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Online Brokers Worth a Look Amid Pricing Battle

We explain our latest views on Charles Schwab, TD Ameritrade, and E-Trade.

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Michael Wong: Investment services firms, such as wide-moat Charles Schwab, narrow-moat TD Ameritrade, and narrow-moat E-Trade, have recently been in the headlines after many of the leading firms decreased their pricing on multiple types of online trade orders to $0. When Charles Schwab made its pricing-change announcement, the share prices of major online brokerages decreased between 10% to around 25%. After adjusting our models for the loss of commission revenue, our fair value estimates generally decreased less than the share prices had fallen--about 5% to 15%. The main reason that our fair value estimates didn’t decrease as much as their share prices is because the market seemed to be pricing the stocks off of the change to near-term earnings, while our fair value estimates are based more on long-term earnings. We had also already been forecasting a decline in commission-trading revenue as a percentage of total revenue before the announcements.

After the commission-pricing cuts, leading online brokerages are still highly profitable with operating margins likely to remain in the mid-30s to 40s, even as the companies face likely earnings headwinds related to interest rates and further competition.

Michael Wong does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.