Should You Buy It: Not Dabbling in Charles Schwab - TheStreet

Charles Schwab (SCHW) - Get Report moved fractionally lower Tuesday, closing at $22.25, while the Dow touched the 14,000 level for the first time. The discount brokerage posted solid second-quarter results yesterday that met analyst expectations.

Schwab earned 23 cents a share, as revenue rose 10% year over year to $1.21 billion. The company posted record nontrading revenue of $1 billion, led by higher asset management fees. The company added 206,000 new client brokerage accounts during the quarter, ending with 6.9 million and $1.38 trillion in total assets.

At current levels, Schwab shares are up 54.3% over the past year and are valued at 23.9 times expected full-year earnings of 93 cents. Not only is that a premium to the 16.3% earnings growth expected from the brokerage this year, but its

multiple is twice what the average traditional investment bank commands and is also above the 14.1 times

P/E and 19.4 times P/E that

E*Trade Financial

(ETFC) - Get Report

and

TD Ameritrade

(AMTD) - Get Report

trade at, respectively.

With that in mind, I'm here to answer readers' questions: Should you buy it? Is Charles Schwab attractive to buy at current levels, or are there better values in the financial sector?

According to a research note from Citigroup earlier this week before Schwab's earnings report, there's more to Schwab than $12.95 commissions. According to analyst Prashant Bhatia, Schwab will pass Merrill Lynch as the largest U.S. brokerage by client assets within the next three years and will double its earnings in the next four years, driven by market-share gains.

On the other hand, while Schwab's trading business accounts for just one of every $6 of revenue generated, it continues to struggle. Daily average revenue from trades fell 2% sequentially from the first quarter, and the company has cut trading commissions 10 times since 2004 because of intense competition.

Still, if you're buying the stock for its growing asset management business, there are cheaper alternatives. For example,

Bank of New York Mellon

(BK) - Get Report

, the world's largest custodial bank that also has $1.2 trillion of customer assets under management, trades at just 19 times expected 2007 earnings.

Schwab announced a plan to return significant capital to investors earlier this month. On July 2, the company said it would pay a special

dividend of $1 a share. Investors at the close of trading July 19 will qualify for the upcoming Aug. 24 payment.

Schwab also said it will buy back 84 million shares, or some 7% of the company, for as much as $22.50 a share, in a modified Dutch auction. Schwab will primarily finance this strategy from the $2.7 billion it plans to clear from the sale of US Trust to

Bank of America

(BAC) - Get Report

, after taxes.

It's worth noting that founder, chairman and CEO Charles Schwab would personally benefit greatly from the moves. Owning some 17% of the company, he stands to receive $252.6 million in dividends over the next year, including the brokerage's 5-cent quarterly payment (0.9% yield). The company will also buy back a proportionate amount of shares from Mr. Schwab in the Dutch auction so that he maintains the same amount of control of the brokerage.

My advice for readers is to avoid shares of Schwab, and for readers who already own the stock, my advice is to take profits.

It looks expensive, not only against the broader market, its peers and the traditional investment banks, but also against other leading asset managers.

And with consumers realizing fewer real estate profits, I believe it will be more difficult for the company to continue attracting assets without acquiring other firms. With that in mind, Schwab lacks the near-term catalysts to continue its rally once the Dutch auction has been completed and the special dividend has been paid.

David Peltier is a research associate at TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Peltier appreciates your feedback;

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