Two Upgrades That Might be Worth a Closer Look
Stifel Financial (NYSE: SF) and Charles Schwab (NYSE: SCHW) were both upgraded today in a busy week for the investment banking sector after Citigroup (NYSE: C) and Wells Fargo (NYSE: WFC) reported earnings and Bank of America (NYSE: BAC) is to follow on Thursday. Last week, JPMorgan (NYSE: JPM) reported disappointing results and S&P downgraded the credit of eight European nations in a move that counterintuitively saw a rally in the stock markets although the euro has climbed.
Goldman Sachs (NYSE: GS) upgraded Charles Schwab to a buy with a price target of $14. Previously the target was $12 with a hold recommendation. While Schwab had previously been hit by a lower net interest margin, an increase in brokerage-related fees and a stabilization of the firm's margin should help it to increase in value, according to the Sachs analysis. Goldman Sachs said that it expects to see annual EPS growth of 15-20%, thanks to fees, increased options integration, and increased capitalization.
The upgrade of Charles Schwab should not surprise any of the discount brokerage's customers. Disappointed with rising banking fees and a seeming contempt for individual consumers amongst the large banks, many have elected to move their money to the brokerage thanks to its offer to refund all ATM fees, even from other companies' ATMs.
Schwab stock spiked in early morning training to settle to an uptick of just .05 in intraday trading, and has settled near its intraday low of 12.11. The jump in price was met by unusually high volume for the stock after a rise in intraday trading. The stock is selling around 20% above its 52 week low of 12.56.
Goldman Sachs also upgraded Stifel Financial to a buy from its previous hold rating and a jump in the price target up to $37. Goldman Sachs is fond of the company again because it expects the full-service brokerage to see an uptick in fees, plus it is more exposed to the U.S. market, which Sachs investors are cautiously bullish on. Analysts at Goldman Sachs also expect the brokerage to increase its "niche-acquisitions, which we expect to continue as it searches for growth." Risks for the brokerage include "lower equity markets or inability to hire," which I see as rather minimal compared to the potential upside thanks to higher fee income.
Goldman Sachs also likes the brokerage's business model because its reliance on fees instead of trading activity makes it a likely candidate to see growth in a volatile but low-volume market that has already hit investment banks (such as Goldman Sachs itself) harder than many full-service brokerages.
Stifel Financial has already done a good job of returning to profitability in 2011, with a net profit margin increase of near zero to 6.55% in 2011, which is expected to grow thanks to its expansion of extra financial service operations.
Stifel Financial is already over 1.3% up in intraday trading.
How to Play the Upgrades
Barring other bad news, stocks usually see an initial uptick in value as upgrades give investors cause for optimism, but such upticks can be short-lived if other bad news comes quickly. In the case of discount and full-service brokerages, a lacking confidence in national and international markets could exposure the companies to lower fee-based revenues as investors spook and return to cash; likewise, low volumes are a concern even for brokerages, who depend on a high number of transactions to earn their fees.
A bearish investor might want to sell short on the initial wave of euphoria, while those who agree with the Goldman Sachs analysts might want to get in now before the companies reach their target prices. However, expect both brokerages' stock prices to mirror the movements of the large investment and commercial banks as their earnings are posted throughout this week.
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