How To Trade The Online Broker Price Wars

Online brokers are engaged in an all-out battle to win over customers.

The latest price war consists of privately-owned Fidelity announcing a reduction in its trading commissions on equity and ETF stocks from $7.95 to $4.95. This was followed by Charles Schwab Corp (NYSE: SCHW) matching Fidelity's price reduction on Tuesday.

Michael Carrier of Bank of America commented in a research report the price competition in the online broker space will continue in the near-term, which will likely put pressure on the stocks. But the analyst added investors are prone to overreacting and there exists the opportunity for "significant" upside from core growth, rising rates and M&A activity.

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Carrier argued the actual impact of the price wars will be "less than expected" since price isn't the only factor that clients consider in selecting a broker. In fact, past price changes haven't always resulted in increased market share for a broker.

Carrier said Schwab generates around 10 percent of its total revenue from commissions and even if it moves to a $4.95 pricing structure the loss of revenue represents around 3 percent of its total revenue.

However, the impact to other brokers will be a bit more pronounced. For example, E*TRADE Financial Corp (NASDAQ: ETFC) generates 23 percent of its revenue from commissions and TD Ameritrade Holding Corp.'s (NASDAQ: AMTD) exposure stands at 31 percent. If these two brokers also move to a $4.95 pricing structure (which isn't expected), the impact to E*Trade will be 5 to 6 percent and 7 to 8 percent.

Finally, the analyst sees Schwab as being a top pick given its lower exposure to commission fees along with the potential for core growth, more expense levels and potential for M&A deals.

Shares of Schwab are Buy rated with a $47 price target.