If Your Broker Calls You, Bang the Phone Down! - Profit Hunter by Equitymaster
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If Your Broker Calls You, Bang the Phone Down!

Apr 10, 2018

Rahul Shah, Editor, Profit Hunter

Never ask a barber if you need a haircut.

Never ask a broker if you should invest in a stock.

In fact: Never, ever, take your stock broker's advice.

Today, I'm going to tell you certain things about the inner workings of the industry to show you why your broker's advice is likely to be at best junk, and at worst dangerous.

First off, how do analysts working with a brokerage get paid?

They get paid by the brokerage firm, of course, who in turn makes its money from commissions every time you trade with them.

The reports and stock recommendations their analysts make are used by the firm mainly as a tool to get you to trade with them.

So, a major problem is that of incentives...

The way these incentives are structured, it creates two problems with the advice they dish out:

  1. They'll try and get you to trade as often as possible; thus the shorter-term the advice, the better. For them, not for you.
  2. The pressure to come up with more 'buy' recommendations than 'sells'. You'll trade with a sell recommendation only if you already own the stock but a buy recommendation is much more likely to elicit a trade (read: money) from many more people. The result is very skewed advice.

But it doesn't end here...

There are other potential reasons for analysts to come up with advice that is not necessarily good for you.

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Another problem is analysts might want to keep a good relationship with the company being recommended.

Again, 'buys' work wonders for this.

Their employers also might have an eye on other business (investment banking/commercial banking) from these companies too. They're then very reluctant to risk offending the company's promoters by dishing out a 'sell' on the stock.

In the process, any 'sell' view is often swept under the carpet.

But wait, there's more...

An independent analysis could be bad for an analyst's career.

The brokerage analyst community often becomes a consensus-building machine, where any individual analyst would much rather try and conform his earnings/target price views to fit in the bounds of what his fellow analysts are expecting, rather then come up with something radically different, and risking ridicule for being wrong.

This makes truly independent advice from the community rare, indeed.

The problem also extends to the kind of stocks included and excluded from coverage.

Analysts end up covering mostly only the biggest names and the most liquid stocks in the stock market. In other words, for the larger brokerages it becomes viable to cover only those stocks with enough volumes to generate enough trading commission. In the process, smaller stocks with relatively lower volumes get ignored, even if they may be the best bargains in the market with more than enough liquidity for an individual investor to buy and sell.

Then there's the sectoral bias.

In the traditional brokerage model, each analyst is assigned a sector that he specializes in and makes recommendations for.

So at the end of the day what you're getting is a recommendation from each analyst judging and comparing investment attractiveness of a stock relative only to other stocks within the same sector, even if the sector as a whole may be unattractive or overpriced.

All of these structural flaws in the way the industry works mean that the analyst community is often way off the mark with their advice.

Sadly, the systemic nature of the problem means the status quo never changes. You can hardly expect to get good investment advice from a stock broker.

We at Profit Hunter - conscious of these flaws in the industry - take pride in the independence of the recommendations we give.

Take our Benjamin Graham inspired service, Microcap Millionaires, for example....

We're not in the brokerage business so have no incentive to make you trade excessively.

The service is industry-agnostic so stocks aren't put in any artificial silos for recommendation.

The service's philosophy takes special care in tuning out market noise while making decisions to ensure the freshness and independence of its views.

And we don't restrict ourselves to highly liquid stocks but rather extend our radar to valuable but obscure stocks that few others cover - in a bid to give subscribers the best bargains the stock market has to offer.

Good Investing,

Rahul Shah
Rahul Shah (Research Analyst)
Editor, Profit Hunter

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2 Responses to "If Your Broker Calls You, Bang the Phone Down!"

DeSa

Apr 20, 2018

People don't use landlines anymore. If they "bang" their mobile phones down, they would break. Mehnga padega, nai?

Like 

Shoaib

Apr 10, 2018

Lol :D Very catchy title and interesting article!!

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Equitymaster requests your view! Post a comment on "If Your Broker Calls You, Bang the Phone Down!". Click here!