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Nicholas Coppola, CFA
October 19, 2018
With recent market volatility, we are rolling up our sleeves and looking for bargains. Over the last week, we took the opportunity to liquidate both our Honeywell International (HON) and Autozone (AZO) positions, as they had exceeded our estimates of fair value. We also trimmed our Allstate (ALL) position in an effort to better utilize capital on investments we believe offer greater upside potential. On the buy-side, we are doubling down on Citigroup (C) and adding a new position in Charles Schwab (SCHW). As a reminder, we initially added Citigroup to portfolios in early August. Since then, Citigroup has reported their Q3’18 results, which provided further confirmation that the business is headed in the right direction, with a 22% year-over-year increase in EPS that beat analyst expectations. For further background on our investment thesis for Citigroup, see our prior letter to clients. To quickly summarize, we continue to believe that Citigroup is attractively valued and will benefit from improved operating efficiencies, a robust share repurchase program, and higher interest rates.
As you are likely well aware, your team at Kays Financial knows Charles Schwab fairly well. Schwab has provided important operational services for our firm since 1991, and we have a great deal of admiration for our partners there. As a result, we have had a first row seat to what management describes as their “virtuous cycle,” where the company endeavors to offer a superior value proposition to clients, which allows them to grow their assets and thus grow their profits, which allows them to further invest in improving their value proposition for clients, which allows them to further grow their assets and thus grow their profits. Similarly, management talks about their ‘no trade-offs’ approach where the company focuses on providing better service at a lower cost, a concept that certainly resonates with customers. And these initiatives appear to be working. Note that since 2008, Schwab has more than tripled their client asset base, which has now reached over $3.5 trillion. At the same time, they have reduced their expenses per dollar of client asset by approximately a third as they leverage their enormous scale.
There are also some significant external drivers of Schwab’s business that we would be remiss not to point out. Importantly, Schwab stands to see a meaningful benefit from rising rates at their banking subsidiary as the Fed normalizes interest rate policy. Our view is that rates will continue to move higher and move the needle for profitability at the company. Risks include the opposite of that (i.e., an extended period of lower rates), a sell-off in the broader market leading to lower retail investor engagement and lower asset values, and pricing pressure on both trading commissions and fees for ETFs & mutual funds.
As an aside, despite our small investment in Schwab, we continue to cheer for lower trading commissions and ETF / mutual fund fees, and believe that the industry continues to head in that direction anyway. And regarding the risk of a broader sell-off, while our crystal ball is admittedly cloudy over the short-term, we are highly confident that stocks will move higher over longer time horizons.
With the stock selling off ~8% over the preceding week, we took advantage of what we believe to be an attractive entry point for a well-managed company with a winning strategy. As we look at valuation, SCHW is now trading at just ~17.0x consensus earnings over the next twelve months, similar to the broader S&P 500. And we believe Schwab to be a far better than average company with a far better than average growth trajectory.
Thank you again for your continued trust and please let us know if you have any questions regarding recent changes to your portfolio.
Nicholas Coppola, CFA
Senior Portfolio Manager
Nicholas Coppola, is a Senior Portfolio Manager at Kays Financial Advisory Corporation. He can be reached at (770) 951-9001 or at firstname.lastname@example.org.
This report and Mr. Coppola’s comments are provided as a general market overview and should not be considered investment or tax advice or predictive of any future market performance. Any security mentioned in this report may not be suitable for all investors. No investment mentioned in this newsletter constitutes a recommendation to buy, sell or hold a particular investment. Such recommendations can only be made on an individual basis after an assessment of an individual investor’s risk tolerance and personal circumstances. Past performance of any investment mentioned is not a guarantee of future performance. Statements regarding the investment concerns and merits of any investment and fair market value computations are strictly the opinion of Kays Financial Advisory Corporation. Employees of KFAC and KFAC clients may have positions and effect transactions in the securities of the issuers mentioned here in.