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Can Brokerage Firms (Wall Street) Make You Money?

This is a tough question with tough answers. I must be brutally honest with you. I would say without hesitation that, at best, it is very difficult for a brokerage firm to make money for its customers. I am going to say some very tough things in this piece and I apologize to anyone that is insulted by what follows, but the pros know that I am right.

You Can't Meet Budget If There Is No Budget
If you work for a corporation now, or have at any point in time you know that every corporation has a budget. When the year is over, people meet and decide how the company did according to the budget that was prepared. In other words, the corporation measures its actual financial performance against the budget for the year.

In the brokerage industry I can walk into any brokerage office and ask the office manager who their best brokers are. They will immediately tell me that this broker grosses a million per year. This other broker grosses two million per year and so forth. What the manager can't tell me is who makes money for their customers. I am in brokerage offices all the time. No manager has ever been able to tell me which brokers are making money for their customers. They can't tell you that because they don't measure it. Now I ask you, if the firms are not measuring broker profitability per customer, what does this tell you? It tells you that it's not a managerial objective and that as a client, you're dead. Unless something is an objective, they're not trying to attain it. If they're not trying to attain it, how are they going to hit it? could make a good case that brokerage firms are not dedicated to making money for you, the client. Brokerage firms are dedicated to maximizing commission revenue from their brokerage force, for the benefit of the securities firm. VSP would be willing to debate any executive at any brokerage firm at any time on this topic, as long as itís a public forum.

There are no HOLDS
All brokerage firms follow a universe of stocks, and they separate them into categories. One firm's categories might be Buy, Sell, and Hold. Another firm may call them, Perform, Outperform, Underperform. This is illogical. I have studied philosophy at graduate school, and I know that it does not take a master's degree to understand that "Hold" doesn't exist. What do you want to buy? The answer is stocks on the Buy listing. Why would you want to hold a "Hold"? The answer is you would not. If a stock were a so-called Hold, you would sell it and put your money into a Buy. Think about it, Holds are really Sells! If you listen to brokerage firms you have to translate the lingo. Get rid of all Holds and buy only Buys.

If the Client is not King, Then Who is King?
The King is investment banking. These are the people in the brokerage firms that do deals. Deals bring in a lot of money. The objective is to do as many deals as possible. The purpose of retail clients is for the firm to be able to feed the deals to retail clients. This gives the investment banking firm clout with potential banking clients. The firm can tell the Fortune 500 client that if you do a deal with us, 20 or 30 percent of your stock will be retailed out, thus giving you better distribution for your stock. It helps firms win deals. Why do you think Morgan Stanley merged with Dean Witter? The bankers at Morgan Stanley would not be found dead in a room with Dean Witter. Morgan Stanley needed Dean Witter's distribution. And where do individual customers rank in all of this? Well, I know it's not first. You the customer might not even be second.

Is the Broker a Portfolio Manager?
No, she is not. She is a trained broker who has passed a test. This in no way means she is capable of selecting stocks that will go up, either near term or long term. As a rule the broker's ability to select stocks is only as good as the firm's research.

They can't all be buys!
I know a brokerage firm with over 1,500 stocks on their buy listing. Look folks, there just can't be 1,500 winners on this planet. Warren Buffett  in his entire career has bought maybe 30 stocks. Think about it, the firm is telling you they have 1,500 winners today. Compare this to 30 stocks for Buffett  over a 30-year period. It just does not make sense. Now if you couple this with timing, you will come to the conclusion that brokerage firms are out of their minds. They may well be.

What happens is that people and organizations get caught up in things. Once caught up, the behavior takes on its own momentum. You'll notice that brokerage firms never publish results of their research on a year to year basis. That's because their performance is so poor that they could not deal with the embarrassment. I know, I have been involved with firms for 30 years.

Research or The Struggle for Mediocrity
I get tons of research from every major and minor firm on the planet. My big problem with that is this: it's all so abominably bad I'm concerned that when I burn it, it could give off toxic fumes and kill me! A second major problem is the paper is not soft, so I can't even use it for toilet tissue. Now, a more serious note. Would you accept the testimony of a dozen doctors under oath that cigarettes do not cause lung cancer if those doctors were hired by Philip Morris? Of course not, and why? Because the testimony is tainted by company that's paying their salaries.

It's the same thing in Wall Street. Research analysts are not independent, and thus they are not objective. You see, their firms do investment banking business with the companies the analysts are recommending. In those cases where the company is not a client of the firm, the firm is hoping to do a deal shortly with the company. Nothing will get a brokerage firm knocked out of a syndicate more quickly than putting out a sell on the potential client company's stock.

Research analysts have careers and families. They want to keep their jobs and their careers, so they're in no position to rock the boat. They are not risk takers. Let me illustrate. In 1980 or 1981, I thought Chrysler was ready to turn after 20 years of failure. My feeling was that the government would lend them several hundred million dollars because Congress was not going to allow hundreds of thousands of auto workers to go unemployed in a terrible recession. At the time I was a limited partner in a major Wall Street firm. I sat down with our analyst who was widely respected throughout the industry and I shared my ideas about Chrysler and the political climate. He looked me straight in the eye and said he couldn't recommend Chrysler. I asked why. He said, "I don't need to hit home runs. Why rock the boat? I look for singles." Chrysler was at $6 at the time. It went to over $125 per share before I started selling. The analyst never recommended it. This analyst is representative of all of Wall Street. Absorb the wisdom I am trying to impart to you.

Can Brokers Make You Money?
The short answer is, yes absolutely. The long answer is you will never find the one who will. Brokers attempting to make money for you are at a great disadvantage compared to other types of money managers. Here are seven good reasons why:

    1) They are paid for doing a trade, whether that trade is a winning trade or a losing trade. There is still a commission involved.

    2) The commission has no relationship to how well the client does. Thus, the broker and the client are in conflict.

    3) Brokers are not paid salaries, they are paid only on commissions. This means every month they start at zero. They must do business to survive. Now I ask you, don't you think your broker has to buy or sell something for your account in order to generate an income for himself for the month ?

    4) Brokers have brokerage licenses. This does not mean that they are security analysts, or certified financial planners, or chartered financial analysts. They do not have to know how to read balance sheets, or income statements to be brokers. Yet, all day long they are involved with stocks. The broker must have a financial understanding of these securities, but at the same time the broker does not have a background in financial analysis.

    5) The cards are stacked against the broker because of the aforesaid. Even the best-intentioned brokers have difficulty making money for people because of the above.

    6) Brokers are on their own. This is why I admire them so much. They are the warriors of the industry. For the most part they are unappreciated by the firms they work for. Every day they are in the trenches trying to do the right thing for their clients. The cards are stacked against them by the systems created by the firms they work for.

    7) The intentions of the broker and the intentions of the client are not united in a win-win situation. So long as the broker's income is not based on the performance of the account, the client will be in trouble. Hopefully, the points I am making will be helpful to you in the pursuit of profit.

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