The tip-ping point only the mavens know
"A broker," said this Mr. Thatcher, "is a true parasite. He is the most overpaid individual in the world. He doesn't produce anything. He doesn't make shoelaces, he doesn't tell you the law, he doesn't make the traffic move. He just takes orders, like a clerk, and for this - do you see the size of those commissions? Fantastic! When trading gets light, brokers scream, they want to raise the commissions. But when the trading goes from five to ten million shares a day, do we hear that commissions are being reduced? We do not. The brokers just sit there piling up money." — Adam Smith (not the famous economist) in The Money Game
Kantilal Shah, on his son's advice, has changed his long-time stock broker. It has been almost a week and there has been no communication whatsoever from his new broker. His old brokers used to keep him informed all the time, giving him weekly tips, and making him buy and sell regularly.
The lack of communication from the new broker made him wonder, "Is this new guy worth all the money he is charging me?"
When he could not take it anymore, Shah called up his broker and gave him a piece of his mind. The broker, taken aback, tried to explain. "But Mr Shah, it's smooth sailing for your investments right now. And if at all there had been a buying opportunity or selling situation, we would have definitely let you know."
"But my last broker used to keep me informed almost on a daily basis and also make me buy and sell regularly. You are not doing anything," responded Shah.
Shah is the kind of client stock brokers love to have. Adam Smith, The Money Game, says
"... the investors who really follow the market, the ones who call up all the time, ninety percent of them really don't care whether they make money or not". As Smith further points out, "If they make a little money, they're happy, if they lose a little money, they're not too unhappy. What they want to do is to call you up. They want to say, 'How's my stock? Is it up? Is it down? What about the earnings? What about the merger? What's going on? And they want to do this every day, they want a friend, they want someone on the telephone, they want to be a part of what's going on".
And to all the questions investors pose, brokers always seem to have the answers. Very few brokers seem to be in the habit of saying I don't know.
But what these investors forget, or are not really bothered about it, is that the broker makes money when the investors buy or sell. No broker has ever made money with an investor holding on to his stock investments. As Smith points out, "They could put you in some stock that would go up ten times, but then they would starve to death, they only get commissions when you buy and sell. So they keep you moving."
These days, stock brokers have got into equity research as well. The reports they bring out list fundamental reasons as to why investors should buy or sell a particular stock. If the report has a buy recommendation, it also has a certain target price, which the analysts expect the stock to reach. Beyond this, the investors are supposed to sell the stock. But what has been observed is that once the stock breaches the target price, a new report with a buy recommendation and an increased target price comes out.
This probably happens because the broker himself owns the stock and does not want the price to fall. There is conflict of interest in this case, even if you build in checks. The fact remains that the owner of both the brokerage and the equity research is the same. Equity research remains a cost function, whereas brokerage activities essentially bring in the revenue.
(The example is hypothetical)
