Simplifying Capital

In this edition of the Smart Investor newsletter, we examine the stock of the largest U.S. retail brokerage firm. With the markets still in flux following the DeepSeek shock, we are not selling any portfolio stocks today. But first, let’s dive into the latest Portfolio news and updates.

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Portfolio Updates

❖ AI-related stocks surged last week after President Donald Trump announced a landmark private sector investment in AI infrastructure through Project Stargate, a joint venture between Oracle (ORCL), OpenAI, SoftBank, and an Abu Dhabi government-backed AI investment vehicle MGX, which will be the initial equity funders of the venture. Oracle is also a key technology partner in the project, along with Nvidia, OpenAI, Arm, and Microsoft (MSFT). The Stargate Project aims to invest up to $500 billion over the next four years to build AI infrastructure in the United States, starting with an immediate deployment of $100 billion. The initial buildout is underway in Texas, with plans to evaluate additional sites across the country for further expansion.

Analysts suggest that companies specializing in AI infrastructure, data center solutions, and advanced semiconductors could become involved as the project evolves. Among the most frequently mentioned as potential beneficiaries are Arista Networks (ANET), Broadcom (AVGO), Micron (MU), Cisco Systems (CSCO), IBM (IBM), Dell Technologies (DELL), and Marvell Technology.

❖ On Monday, last week’s uptrend in AI-related stocks reversed abruptly as Chinese AI startup DeepSeek unveiled a new chatbot rivaling ChatGPT in performance, shaking up the tech industry.

Shares of major tech players fell sharply amid concerns that China’s AI advancements could challenge the dominance of U.S. companies. Nvidia’s shares tumbled by 17%, marking the largest market-cap loss in history. Other AI infrastructure companies, including portfolio holdings Arista Networks (ANET) and Broadcom (AVGO), suffered similar drops, as did some of the energy stocks associated with powering data centers, and several industrial names supporting the industry. However, the more diversified Alphabet (GOOGL) and Microsoft (MSFT) fell by a much smaller percentages. Meanwhile, several prominent tech names – including Apple, Amazon (AMZN), and Salesforce (CRM) – registered gains, highlighting that this was not a broad-based market decline but rather a shakeup amid elevated valuations.

DeepSeek’s chatbot, built on its open-sourced R1 reasoning model, quickly overtook ChatGPT as the top-rated free app on Apple’s App Store, surpassing it on the U.S. download list. DeepSeek’s claims of training its R1 LLM at a fraction of the cost, in less time, and with far fewer GPUs than its Western counterparts further rattled sentiment, especially following announcements of massive AI investments at project Stargate, in addition to Microsoft’s and Meta’s plans to ramp up their AI investments to $80 billion and $60-65 billion, respectively.

DeepSeek asserts it trained its R1 model for under $6 million using approximately 2,000 Nvidia GPUs – an astonishing claim compared to the billions of dollars and tens of thousands of GPUs required for U.S.-developed models. If true, it could pressure U.S. companies to justify their skyrocketing AI-related capex.

Some tech industry insiders say that the Chinese firm has in fact amassed 50,000 advanced Nvidia H100 GPUs, which it cannot admit to having due to the U.S. export restrictions. In addition, even if its claims are true, the Chinese AI model still has been built on already existing technology and leveraging existing models. Whether or not DeepSeek’s methods are more efficient, reliance on stockpiled GPUs rather than Chinese-made hardware is not a sustainable long-term strategy. The company’s founder has already acknowledged to Beijing’s government that U.S. export restrictions are posing challenges. With trade restrictions on AI hardware expected to tighten further, Chinese firms lacking access to advanced chips face significant hurdles in maintaining competitiveness.

Many analysts are also skeptical of DeepSeek’s claims. Bernstein called the $6 million figure “categorically false,” dismissing the idea that China replicated OpenAI’s capabilities at such a low cost. Most analysts see the sell-off as an overreaction, viewing it as a buying opportunity given the enduring demand for AI infrastructure and the robust positions of leading U.S. tech companies. Thus, Wedbush analysts said that no major U.S. corporation would rely on a Chinese startup like DeepSeek for building their AI infrastructure, due to trust, geopolitical concerns, and regulatory risks. According to Wedbush, Nvidia remains the only chip company capable of enabling large-scale AI infrastructure for autonomous systems, robotics, and advanced AI applications. Bernstein, Mizuho, Cantor Fitzgerald, Citi, and others also opined in favor of American AI names like Nvidia, Broadcom, and others. Jeffries analysts specifically mentioned Oracle, saying they see no justification for the sell-off, as core AI capacity demand has not changed.

More than anything, DeepSeek’s onslaught is a sobering wakeup call that China’s AI capabilities could be advancing quicker than previously thought, despite the U.S. sanctions. As such, the “AI arms race” may accelerate even faster, with the apparent Chinese advancement triggering even more U.S. and European government support in terms of funding, grants, and tax relief, as well as additional curbs on exports to China.

❖ GE Aerospace (GE) reported a strong Q4 2024 revenue and earnings beat, with adjusted EPS surging by over 103% year-over-year. Looking ahead, GE provided an optimistic 2025 outlook, expecting double-digit revenue and EPS growth with greater than 100% free cash flow conversion. The company also announced a 30% dividend increase and a $7 billion share buyback program, further bolstering investor confidence.

❖ Amphenol (APH) saw its stock receive PT upgrades from a slate of analysts after it reported its Q4 2024 results. The company revealed record operating margin, revenue and EPS (both GAAP and adjusted), surpassing analyst expectations on all accounts despite some challenges in the broadband segment and European market. APH also reported record orders, driven by continued strength in the IT datacom market, as sales in this key segment surged by 60% YoY. Looking ahead, Amphenol anticipates continued strong momentum, guiding for Q1 2025 revenue growth of 23-26% year-over-year and EPS growth of 23-28%.

❖ ASML Holding N.V. (ASML) surged in pre-market trading following the release of its Q4 2024 and full-year results. The Dutch chip-equipment giant beat analyst estimates for quarterly revenue and EPS by a wide margin, with revenue increasing 28% year-over-year. Additionally, net bookings in the quarter surged 170% year-over-year, coming in twice as high as expected. This signals strong future demand, alleviating some concerns raised by the DeepSeek revelations.

Quarterly net bookings were driven by robust demand for ASML’s most advanced EUV machines. The company continues to benefit from accelerating investments in AI-driven capacity expansion, including Meta’s planned capital expenditure hike and investments tied to Project Stargate. Meanwhile, the share of revenue derived from China declined further, with ASML expecting this trend to persist as it fulfills order backlogs from previous years.

ASML achieved another record year in 2024, reporting total net sales of $29.7 billion with a gross margin of 51.3%. Looking ahead, the company forecasts Q1 2025 total net sales of $7.9-8.4 billion with a gross margin of 52-53%. ASML maintained its full-year 2025 net sales guidance at $31.5-36.8 billion. Further boosting investor confidence, the company raised its annual dividend by approximately 5%.

❖ D.A. Davidson analysts highlighted Alphabet (GOOGL) as a significant potential competitor to Nvidia in the AI hardware market, primarily due to Google’s development of tensor processing units (TPUs) designed for machine learning tasks. These TPUs have been adopted by companies like Apple for training models. However, analysts point out that Google has not aggressively pursued the broader hardware market, making it challenging for external developers to access TPUs. In contrast, Nvidia offers a robust developer ecosystem, which has contributed to its leading position in AI hardware. D.A. Davidson estimates that Alphabet’s TPU and Google DeepMind AI businesses could be worth $700 billion, suggesting a combined value of $3.5 trillion for the company if it fully leverages its diverse business ecosystems. Currently, Alphabet’s market cap is valued at $2.46 trillion.

❖ KKR & Co (KKR) has announced plans to combine its infrastructure and real estate assets that are worth a total of $157 billion in AUM. These assets will be merged into a new unit, Real Assets, as the private equity giant seeks to capitalize on the growing convergence between infrastructure and real estate, exemplified by the boom in data centers. Data centers are both physical real estate assets (requiring land and buildings) and infrastructure investments (involving utilities, cooling systems, and connectivity). By merging, KKR can centralize decision-making and capital deployment for AI data centers, enabling them to target opportunities more aggressively and with greater scale.

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Portfolio Stocks Under Review

❖ We have removed GE Aerospace (GE) from our “Under Review” bracket for now, following its strong earnings report and raised outlook.

❖ Our newest Portfolio addition, Micron (MU), has been hard hit by the DeepSeek rout, along with other hardware and infrastructure stocks. While its long-term investment case remains intact, we intend to follow the stock to see whether it is able to shake off short-term investor negativity.

❖ We are also placing Dell Technologies (DELL) under review for the same reason: negative investor sentiment weighing on the stock in the past month, which was further exacerbated by the stock rout caused by the DeepSeek developments. While we believe in the company’s outstanding long-term potential, this “sticky” negativity may force us to sell the stock.

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Portfolio Earnings and Dividend Calendar

❖ The next several days will be busy with Smart Portfolio companies’ earnings reports. Microsoft (MSFT) and IBM (IBM) are scheduled to report today after the market closes. Parker Hannifin (PH), and Visa (V) are expected to reveal their quarterly results tomorrow, while PayPal (PYPL), KKR & Co (KKR), Pentair (PNR), and Alphabet (GOOGL) are slated to post their earnings on February 4th.

❖ The ex-dividend date for Metlife (MET) is February 4th.

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New Buy: Charles Schwab Corp. (SCHW)

Charles Schwab Corporation is a financial services company that provides a wide array of investment and wealth management solutions to individuals and institutions. SCHW is a prominent leader in the brokerage and financial advisory industry, known for its innovative trading platforms, retirement planning services, and low-cost investment products. It dominates the market for investor-focused financial solutions, enabling accessible and efficient wealth-building opportunities for clients worldwide.

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Commission-Free Evolution

Founded in 1971 by Charles R. Schwab, Charles Schwab Corporation transformed the financial industry by pioneering discount brokerage services in the wake of commission deregulation in 1975. Throughout the 1980s and 1990s, Schwab expanded rapidly, introducing branch offices, toll-free trading, and online trading in 1996, one of the first instances in which technology was deployed to empower retail investors.

In 2019, Charles Schwab made a groundbreaking move by eliminating trading commissions for U.S. stocks, ETFs, and options, dropping fees from $4.95 per trade to $0. This bold decision disrupted the brokerage industry, forcing competitors like Fidelity, E*TRADE, and TD Ameritrade to follow suit. The move significantly lowered barriers for retail investors, democratizing access to financial markets. Schwab’s zero-commission policy attracted a wave of new accounts, particularly from cost-sensitive investors, solidifying its position as a retail brokerage leader and accelerating the industry’s shift toward fee-free trading models.

Over the past decade, Schwab’s growth has been driven by major mergers and technological advancements. The company’s 2020 $22 billion acquisition of TD Ameritrade was a transformative move, creating the largest U.S. retail brokerage firm by client assets. This merger expanded Schwab’s client base and integrated TD Ameritrade’s advanced trading tools, including the widely popular Thinkorswim platform.

SCHW has also invested heavily in technology to enhance its digital offerings. The company continues to refine its robo-advisory service, Schwab Intelligent Portfolios, catering to clients seeking automated, low-cost solutions. Additionally, Schwab introduced an improved mobile app and advanced trading features for active investors, further solidifying its leadership in financial technology.

Today, with a market cap exceeding $150 billion and annual revenues of almost $20 billion, Schwab ranks #160 in the Fortune 500 list.

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Streams of Strength

With over $8 trillion in client assets under management (AUM), Charles Schwab is a leader in the financial services industry. Its AUM spans brokerage accounts, advisory and managed accounts, and retirement and institutional services.

The majority of Schwab’s assets are held in brokerage accounts, where clients use its platform to trade and invest. Schwab also directly manages or advises on assets through services like Schwab Wealth Advisory and Schwab Intelligent Portfolios, its robo-advisory platform. Additionally, 401(k) plans, IRAs, and institutional clients contribute significantly to total AUM.

SCHW’s revenue streams are diverse. Net interest revenue, nearly half of total revenue, comes from client cash balances, loans, and securities. Schwab’s banking arm, integrated with its brokerage services, enhances cash management and provides lending solutions, including margin loans, home mortgages, and personal loans. The company also invests client cash deposits into fixed-income securities and other instruments, generating significant interest income.

Asset management and administration fees, contributing over 30% of total revenue, are derived from Schwab’s in-house investment vehicles, such as the Schwab Index Funds and Schwab ETFs. Additionally, the company collects administration and service fees from third-party mutual funds and ETFs available on its platform and earns fees from advisory services offering tailored or automated portfolio management.

Trading revenue, 14% of total revenue, includes commissions, transaction fees, and payments for order flow, where market makers pay Schwab to route trades. The remaining revenue comes from various service fees and exchange processing income.

The high level of diversification of SCHW’s revenue streams – spanning interest income, asset management, and trading – provide resilience against market fluctuations, ensuring consistent growth and stability while meeting the needs of individual investors, financial advisors, and institutional clients across varying economic conditions.

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Efficiency Meets Resilience

While Charles Schwab carries significant debt, its cash and cash equivalents are more than 2.5 times its long-term liabilities. The company’s high investment-grade credit ratings – “A” from Fitch, “A-” from S&P, and “A2” from Moody’s – underscore the strength of its balance sheet. Fitch specifically highlighted Schwab’s “strong franchise in the mass-market retail investor space and within the asset/wealth management space,” as well as its “solid and improving regulatory capital levels and substantial available liquidity.”

Schwab demonstrates robust capital efficiency, profitability, and cash generation metrics. Its ROA aligns with industry averages, while its ROE exceeds that of 75% of its peers. Similarly, SCHW’s net profit margin is in the top 25% of the industry, and its free cash flow (FCF) margin ranks in the top 10%. Its Liquidity Coverage Ratio (LCR) reflects strong liquidity management, while other metrics, such as Net Interest Margin (NIM) and Efficiency Ratio, also compare favorably with industry averages, highlighting its solid financial position and effective management.

Over the past decade, SCHW’s revenue has grown at a 12.6% CAGR, while its EPS increased at a 12.1% CAGR. The company consistently surpasses analysts’ expectations: over the past two years, every quarterly report has featured revenue and earnings results exceeding consensus estimates by a wide margin.

Schwab’s Q4 2024 report was particularly well-received, with revenue up 20% year-over-year and adjusted EPS surging 49%. Net interest revenue increased by 19%, asset management and administration fees grew 22%, trading revenue rose 14%, and bank deposit account fees jumped 39% YoY. Additionally, Schwab gained $115 billion in new client assets during the quarter, bringing total asset growth for the year to $367 billion – a 20% increase from 2023, driven by steady growth following the TD Ameritrade integration. New brokerage account openings rose 23% YoY, reaching a record 36.5 million active accounts. Further demonstrating positive client engagement, Schwab earned the title of “America’s Best Customer Service 2025” from Newsweek, and its mobile app was ranked #1 for investing by Corporate Insight.

Looking ahead, Schwab expects to expand its NIM to approximately 2.80% by the end of 2025, driven by reduced reliance on high-cost supplemental funding for its banking operations. The company also projects total revenue growth of 13%-15% in 2025, alongside an adjusted pretax margin in the upper 40% range and Q4 2025 margins approaching 50%, reflecting strong positive operating leverage.

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Capital Confidence

Schwab’s guidance includes plans to expand capital returns to shareholders in 2025 and beyond, building on its existing dividends and share buyback program. This reflects the company’s confidence in its financial strength and ability to generate surplus capital.

The company has paid a dividend for 35 consecutive years. While its current dividend yield of 1.22% is modest compared to the financial sector average, Schwab’s dividend has grown steadily over time and is expected to continue increasing. This growth is supported by Schwab’s strong earnings trajectory and robust cash flow, which keep its payout ratios at conservative levels.

Schwab also maintains an active $15 billion share repurchase authorization, established in July 2022. Although no shares have been repurchased under this authorization so far, the significant strengthening of its balance sheet during 2024 has led the company to indicate that it is poised to resume buybacks in 2025.

Having gained about 31% in the past 12 months, SCHW now trades at a premium to the Financial sector’s averages. However, its valuation is moderate compared to industry peers, positioning it in the middle of the peer valuation spectrum. With a forward P/E ratio below 20x and revenue growth projections exceeding most competitors – except for Interactive Brokers (IBKR), a Smart Portfolio company – Schwab presents an attractive investment opportunity.

The accelerating activity in retail trading further bolsters the bullish outlook for financial services firms, particularly those capable of attracting client assets at scale, such as Schwab. This optimism is reinforced by recent price target upgrades from leading analysts at UBS, Barclays, Citi, Deutsche Bank, Argus Research, Wells Fargo, and others.

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Investing Takeaway

Charles Schwab Corporation is a leader in financial services, excelling in brokerage and wealth management with a strong presence in retail and institutional markets. The company’s innovative trading platforms, zero-commission model, and strategic acquisitions have solidified its position as a market disruptor. Schwab’s highly diversified revenue streams underscore its resilience and consistent growth. Strong financial fundamentals, robust profitability metrics, and exceptional liquidity management reflect its operational excellence. With plans to expand shareholder returns through growing dividends and a substantial buyback program, Schwab projects confidence in its financial strength. The company’s focus on technology-driven solutions enhances client engagement and satisfaction. Positioned for above-average revenue growth and supported by expanding retail trading and asset gathering, Schwab combines innovation, stability, and shareholder value. We believe it is a compelling addition to a forward-looking investment portfolio.

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Smart Investor’s Winners Club

The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.

Despite Monday’s market bloodbath, the Winners’ ranks have expanded, thanks to the strong gains in AMZN shares. Our exclusive club now includes 17 stocks: GE, AVGO, ANET, TPLTSM, EME, ORCL, HWM, IBKR, PH, APH, KKR, ITT, CRM, PYPL, PNR, and AMZN.

The first contender is now DKS with a gain of 18.97% since its purchase on December 4th. Will it close the gap, or will another stock outrun it to the finish line?

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New Portfolio Additions

Ticker Date Added Current Price
SCHW Jan 29, 25 $81.70

Current Portfolio Holdings

Ticker Date Added Current Price % Change
GE Jul 27, 22 $194.43 +247.94%
AVGO Mar 22, 23 $207.36 +228.67%
ANET Jun 21, 23 $106.54 +181.26%
TPL Jun 5, 24 $1275.23 +118.18%
TSM Aug 23, 23 $202.40 +115.80%
EME Nov 1, 23 $438.27 +112.37%
ORCL Dec 21, 22 $164.00 +101.23%
HWM Apr 10, 24 $126.41 +91.97%
IBKR Jun 19, 24 $207.75 +73.50%
PH Oct 11, 23 $666.23 +67.47%
APH Aug 9, 23 $68.58 +55.09%
ITT Oct 18, 23 $146.49 +53.38%
KKR Jun 12, 24 $167.05 +51.57%
CRM Sep 4, 24 $359.95 +45.11%
PYPL Apr 17, 24 $88.19 +39.04%
PNR Jun 26, 24 $102.73 +38.25%
AMZN Sep 11, 24 $238.15 +32.64%
DKS Dec 4, 24 $249.23 +18.97%
GOOGL Jul 31, 24 $195.30 +14.69%
BRK.B Aug 7, 24 $469.97 +11.33%
RGA Nov 6, 24 $229.94 +7.97%
IBM Nov 20, 24 $225.66 +7.33%
V Jan 1, 25 $334.48 +5.83%
MET Jan 8, 25 $85.68 +4.31%
ADSK Dec 25, 24 $309.93 +2.89%
MSFT Sep 18, 24 $447.20 +2.77%
CSCO Dec 18, 24 $59.43 +1.56%
ASML Oct 16, 24 $683.35 -0.78%
FANG Oct 30, 24 $169.25 -3.64%
MTDR Jan 15, 25 $60.28 -3.91%
UBER Nov 27, 24 $68.07 -4.88%
DELL Mar 27, 24 $101.29 -11.65%
MU Jan 22, 25 $88.25 -19.32%

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Disclaimer

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