Charles Schwab (SCHW) made headlines twice in the past two months with two bold moves that are changing the landscape of the brokerage business and positioning it to dominate the money management industry for years to come. 

The first bold move came in early October when Schwab effectively dropped commission rates on all trades to zero.  Initially, shares of Schwab dropped some 15% on the news.  But they recouped those losses within the month as investors came to appreciate that not only did the move allow SCHW to compete more effectively with a new platform such as Robinhood and SoFi which offer free trading, but the reality is trading commissions only accounts for 10% of SCHW’s revenue — even less of its profits.  

Competitors such as TD Ameritrade (AMTD) and E*Trade (ETFC), which quickly matched the zero commission offer, were hit even harder as their shares fell over 25% and had only regained about half of that in the following weeks.  

The second bombshell came in late November when Charles Schwab announced it would acquire TD Ameritrade in an all-stock deal that initially valued the latter at $26 billion.  It amounted to about a 25% premium to what TD was trading at the time, which essentially got shares back to the pre-zero commission level.  

Essentially, Schwab went from the dragon, laying waste the industry to a knight in shining armor rescuing at least one damsel it had put in distress.  E*Trade was not so lucky and is now likely going to need a larger suitor itself. 

Basically, in a few short weeks, Schwab took what some considered a potential weakness in its business model (it only gets about 7-8% of its revenue from actual trading activity, versus around 25% for most competitors) and turned it into an extremely sharp sword.

The speed at which it swooped up Ameritrade makes me think this was part of the plan all along. 

By resetting the trading industry to zero commissions, a move that competitors had no choice whatsoever but to follow, it ensured that its stock price would be hit far less than competitors giving it the currency to acquire newly desperate competitors.

Investors applauded this as a savvy move as Schwab shares surged some 5% on the news. But, the stock is still some 15% below the all-time high it hit in June of 2018.

I think the stock will easily surpass that old high within the next year and could more than double within the next five. 

For starters, the acquisition, or really, the absorption of Ameritrade is expected to produce tremendous cost savings. The company believes that by the end of the third year following closing, it can generate annual run-rate synergies between $3.5 billion and $4 billion. To put this in perspective, these synergies represent a whopping 60% to 65% of TD Ameritrade’s expense base, and it should easily offset the decision by both firms to no longer charge commissions on many of their trades.

Schwab is also now positioned to do some very interesting and disruptive things. In both the most vertically integrated financial services platform, and the most integrated financial services platform.

The obvious place is in asset management: It’s not just a distributor, it manufactures its own funds and ETFs, and is solid. But it also controls almost every component of its business, from recordkeeping to a trust bank to a retail bank to insurance agencies. 

In a way, Schwab’s move reminds me of Amazon (AMZN) and its founder Bezos’s famous statement, “Your margin is my opportunity.” 

Schwab saw commissions were heading towards zero, it simply gave it a shove and now is positioned to dictate how many other facets of the financial industry will operate.  And in the process, it should continue to gather assets and generate profits. 

AMTD shares were trading at $51.11 per share on Tuesday afternoon, down $0.68 (-1.31%). Year-to-date, AMTD has gained 7.03%, versus a 25.25% rise in the benchmark S&P 500 index during the same period.

About the Author: Option Sensei

Steve has more than 30 years of investment experience with an expertise in options trading. He’s written for TheStreet.com, Minyanville and currently for Option Sensei. Learn more about Steve’s background, along with links to his most recent articles. More...

More Resources for the Stocks in this Article