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Fool’s Eye View: Brokers That Can Make You Rich

It seems that the only time that many of us will ever contact our brokers these days is when we have a problem. It could be because a dividend payment that we were expecting has gone astray. Or it could be that our broker has made a mistake with our trading fees.

Thing is, with so much information freely available on the Internet, we hardly ever need to ask brokers what we should buy or what we should avoid, anymore.

However, there are still plenty of people who not only like to use brokers but will even gladly pay for their services. It helps them feel more comfortable about their investing decisions. And if a broker or remiser can add value to your investments, then why not?

Additionally, some stockbrokers and some remisers don’t just trade shares on our behalf, anymore. Some help their clients organise their finances and identify suitable investments. Some might even advise clients on ways to improve the complexion of their portfolios.

Apart from retail brokers, there are also corporate brokers who specialise in servicing businesses. They help corporate clients raise funds, identify suitable merger and acquisition targets, and assist businesses to float on the stock market. And with the raft of fintech unicorns set to list on stock markets around the world, some of those brokers could be set for a windfall.

A geared play

What’s interesting about stockbrokers is that many can struggle to make money in a bear market. That’s not too surprising given that many investors tend to avoid shares in the face of uncertainty. That can have an impact on the profits of brokers. But in a bull market brokers can do exceptionally well.

That’s because brokers are said to be a geared play on the market. Essentially, if the market does well, then shares in stockbrokers could do even better. For instance, prior to the financial crisis of 2008, brokers were making money hand over fist. It was hard for them not to rake in the profits. Their average profit margins were in the high teens. Some, that include Singapore’s UOB-Kay Hian (SGX: U10), registered net income margins in excess of 30%.

But it was a different story when the great financial crisis struck. In 2009, those high margins quickly evaporated. Some even reported annual losses. It just goes to show how quickly things can change, when a company is a geared play on stock market conditions.

Thankfully for brokers, the recovery in global stock markets arrived quickly because of the decisive action by central bankers. Led by the US Federal Reserve, other central banks flooded the world with cheap money. The net income margins of brokers quickly recovered, if not exceed pre-financial crisis levels.

Exotic drivers of returns

Those high net income margins have been important drivers for the returns on equity for brokers. On average, brokers have generated around $9 of bottom-line profit for every $100 invested by shareholder in those businesses. Some of the highest include IG Group, CMC Markets and TD Ameritrade. They specialise in popular, exciting and exotic trading products such as contract for difference.

Some brokers make use of borrowings to help boost their returns on equity, too. On average, debt to equity is around 80%. But some brokers have considerably more debt than equity. That can be worrying. Whist leverage, or the use of other people’s money, can help to juice returns when times are good, they can have the opposite effect when credit is harder to come by.

Some of the more highly leverage brokers include CITIC Securities, Haitong Securities, which are listed on the Shanghai Exchange, China Galaxy, which is listed on the Hong Kong Stock Exchange, and Guosen Securities, which is listed on the Shenzhen Stock Exchange.

Currently, the valuations of brokers look rich. The average price-to-earnings ratio is bunched around 20. That means we are paying $20 for every dollar that brokers make in profit. That feels quite expensive. The best time to have bought would have been just after the great financial crisis, when the average valuation was only around 12 times earnings. Some brokers were valued as low as six times earnings.

Additionally, the average dividend yield for brokers, which is below 2% seems to confirm that they are not especially cheap. Perhaps the market thinks that brokers could continue to benefit from the bull market that shows little sign of slowing. It’s hard to argue against that with interest rates expected to remain lower for longer.

A version of this article first appeared in The Business Times.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.