Fernando MonteiroThe Perversity of Stock Market Brokers’ Thinking
November 30th 2009 13:14
Brokers think differently than long-term investors, which is no surprise if we think that brokers do substantially different activities than investors. Find out more below.
Investors are interested in buying companies that have good business/earnings prospects and generally think of associating with them for a substantial amount of time. They reap capital gains and dividends and generally only sell if they think that their companies have become lacklustre or too overvalued.
Brokers though, are there for something substantially different: basically, they are there to buy and sell shares for investors that place orders with them. In principle this would be all that brokers should be doing. But they then, and keeping with the truth, to fill up free time and free money, play some games with the stock market. And not all are recommendable.
For example, in order to lower the purchase price for some stock they want to buy, they might first sell in order to lower the market price for the security and then buy. Do you, dear reader, get the feeling that this is likeable to passing the cards under the table? They call this operation and its converse “smoothing the price”.
Another example of brokers’ activities is short-selling. Short-selling is a despicable practice for it downgrades companies’ market values for no good reason and the only person that profits from it is the broker. The broker “borrows” a number of shares from one of its client, often without permission, and sells them into a falling market. He then buys the same number of shares back at a much lower price and pockets the difference.
This practice has aberrant consequences: (a) in the stock market we buy or sell shares – nobody really borrows them. What brokers do then is illegitimate. (b) short-selling depresses prices abnormally. When in mid 2008 Macquarie Group was short-sold its price fell from the highs of $91 to a ridiculous $15, much below its then value and much to the dismay of its shareholders. (c) short-selling has this additional bizarre characteristic: you sell a company but do not mean to leave it behind. When the regular investor is done with a company he sells its shares and that’s it. When the short-selling broker sells its shares he means to continue to affect the company’s share price. How fair is this?
To give way to their trigger-happy tendencies brokers in their free time practice games of speculation. They basically shoot at anything that goes up, going long, in order to pocket a small difference in price. They might not be buying for any client, but just making a few bucks here and there. This has interesting consequences in terms of what the thinking of a broker is and what the thinking of a long-term investor is.
One example of this is how Price to Earnings (P/E) is understood by these two different types of stock market people. P/E is share price divided by earnings per share and expressed in times. For the long-term investor, at buying time it’s important that, once the company under analysis is seen to have some value, that its stock price be as low as possible. This means that P/E must be low, as low as possible and certainly below 15 times. This is sensical.
A broker though, has a perverted thinking about this: he thinks that the highest the P/E the better. The reason is that very high P/Es are associated with companies that present some prospects for speculation and whose price is volatile, therefore allowing brokers to play their conjecture and rumour games.
Much more could be said about the perversity of stock brokers’ thinking but this should suffice to open the appetite to find out more.
Investors are interested in buying companies that have good business/earnings prospects and generally think of associating with them for a substantial amount of time. They reap capital gains and dividends and generally only sell if they think that their companies have become lacklustre or too overvalued.
Brokers though, are there for something substantially different: basically, they are there to buy and sell shares for investors that place orders with them. In principle this would be all that brokers should be doing. But they then, and keeping with the truth, to fill up free time and free money, play some games with the stock market. And not all are recommendable.
For example, in order to lower the purchase price for some stock they want to buy, they might first sell in order to lower the market price for the security and then buy. Do you, dear reader, get the feeling that this is likeable to passing the cards under the table? They call this operation and its converse “smoothing the price”.
Another example of brokers’ activities is short-selling. Short-selling is a despicable practice for it downgrades companies’ market values for no good reason and the only person that profits from it is the broker. The broker “borrows” a number of shares from one of its client, often without permission, and sells them into a falling market. He then buys the same number of shares back at a much lower price and pockets the difference.
This practice has aberrant consequences: (a) in the stock market we buy or sell shares – nobody really borrows them. What brokers do then is illegitimate. (b) short-selling depresses prices abnormally. When in mid 2008 Macquarie Group was short-sold its price fell from the highs of $91 to a ridiculous $15, much below its then value and much to the dismay of its shareholders. (c) short-selling has this additional bizarre characteristic: you sell a company but do not mean to leave it behind. When the regular investor is done with a company he sells its shares and that’s it. When the short-selling broker sells its shares he means to continue to affect the company’s share price. How fair is this?
To give way to their trigger-happy tendencies brokers in their free time practice games of speculation. They basically shoot at anything that goes up, going long, in order to pocket a small difference in price. They might not be buying for any client, but just making a few bucks here and there. This has interesting consequences in terms of what the thinking of a broker is and what the thinking of a long-term investor is.
One example of this is how Price to Earnings (P/E) is understood by these two different types of stock market people. P/E is share price divided by earnings per share and expressed in times. For the long-term investor, at buying time it’s important that, once the company under analysis is seen to have some value, that its stock price be as low as possible. This means that P/E must be low, as low as possible and certainly below 15 times. This is sensical.
A broker though, has a perverted thinking about this: he thinks that the highest the P/E the better. The reason is that very high P/Es are associated with companies that present some prospects for speculation and whose price is volatile, therefore allowing brokers to play their conjecture and rumour games.
Much more could be said about the perversity of stock brokers’ thinking but this should suffice to open the appetite to find out more.
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