The brokerage industry is all about complex operations which are not easier to understand, so most fail to profit from the trends in this industry. At the same time this industry is a cyclic in nature and hence involves substantial risks. Brokerages are also commonly known to provide financial services including different investment solutions to their clients. These include opportunities for their clients to invest in different exchanges and deal in currencies, stocks, commodities and a whole host of asset classes.
Brokerages are considerably diversified. Most of their profits and income is derived from filling buy and sell orders from their clients. A broker can meet a client’s trade request in two ways. First by acting as an agent, this would involve him being an intermediary for the order. He would match a customer’s buy order with a third-party’s sell order and vice versa. A broker as an agent is paid a commission for this task. A broker can also act as a principal. A broker in this mode meets a customer’s order from his/her own stock. Revenue through such transactions is calculated on the basis of the gain or loss incurred by brokerage over its own investments.
Fee based revenues are categorized under “others”. Such fee is calculated as a percentage factor of a client’s assets. They also earn interest on their investments and dividends, minus the interest they pay on debt. Many such companies also generate income via investment banking services, providing advisory services involving stock or bond acquisition and mergers. Principal Transactions, Interest Income, and Investment Banking revenues depend on the market conditions, and can be low or high depending on the market, however commissions prove to be stable. During down market commissions prove to be a good stable source of income if client trading sees an upsurge.
The biggest expense full-service brokerages face is compensating their workforce for services rendered. Employees are rewarded on the basis of the total commission, trading and investment banking revenue that they contribute to the company. They are then given a percentage of the revenue that they bring into the company.
The profit that a brokerage generates is calculated by taking into account their trading volume, the fees they charge, costs incurred by the company (compensation to employees etc.). During times of heavy trading brokers incur heavy profits.
Brokerages suffer from varying levels of debts, however with smart investments heavy gains can help cut down on their debts. Some companies who depend mostly on commissions play safe and incur lesser debts.
Exchanges are marketplaces for traders to buy and sell securities. Earlier in history trading used to take place on open spaces, with face to face transactions and contact taking place.
However, today exchanges operate electronic systems, allowing for efficient and prompt trading. Several exchanges today continue to use traditional trading floors, but in combination with electronic systems. There are several ways of revenue generation in exchanges. Some concentrating on the equity market receives fees from listed companies. Equity and derivative exchanges both collect fees for each trade done utilizing their platform. Such exchanges exploit a volatile market to their fullest and draw heavy revenue via this channel.
Exchanges also draw revenue by providing market data to financial information providers. Clearing third party trades, developing and distributing trading technology and information processing are some other methods of generating revenue. Exchanges have fixed cost structures as compared to brokerages. Operating performance is on the basis of transaction volume. When trading increases margins also see a rise and margins vice versa. With increased reductions in fixed costs, operating leverage sees a surge. Exchanges sometimes take on debt to make promising acquisitions. Improved cash flow helps lighten this burden. Exchanges have seen considerable consolidation. Several exchanges now reach out to foreign companies to diversify and to seek newer avenues.
This industry has a cyclic nature, so investors should be willing to take risks originating because of market volatility. The equity market is also a strong indicator of the economy, a booming equity market ensures the market is fueled enough to show growth. Several companies here also pay dividends. Hence these stocks are the best options for those looking for worthwhile price appreciation potential and can handle market volatility.