Earlier this week we talked about investing based on trends, and I pointed out one long-lasting trend that should drive homebuilders higher by several multiples in the years ahead.
While I think you would probably do pretty well just buying and holding on builders at the current levels, I am not satisfied with just doing well. I want to do exceedingly – two stages past fantastic – well.
To do that, I wait for the individual companies to come into buy range based on my numbers-oriented approach to stock selection. Catching a significant social, demographic, or economic trend in the markets can be a good thing. Finding one at a bargain price is a spectacular thing.
So today, I want to talk about another huge trend that is going to change an entire industry completely.
20%, 25%, and 30% Fees Be Gone! Thanks to This Consolidation Trend
When I started out as a broker, it was a different world.
Mutual funds not only had management fees well above what is charged today, many of them had an 8.5% sales commission! Stock trading commissions were somewhere around 2% for each side of the trade, and futures brokers were getting $100 per round trip trade or more.
It wasn’t just the retail investors paying through the nose either. Institutional trades were $.08 per share. Investment banking fees were 7%, period. IPO and secondary offering fees were the same, and there was no arguing or haggling. Everybody paid the full price. Investment firms made tons of money and paid for big shiny buildings all over mid-town, and investors and corporate boards played along or did without.
It was a different world for sure. If you wanted a stock quote, you didn’t just pull out your phone. You had to call your broker, and their assistant would enter the ticker into a Quotron and tell you the price. Of course, if you liked a little action, you could go into the office and watch the ticker tape scroll by with all the other retirees whose wives kicked them out of the house for the day.
To open an account, you had to go to the office and talk with actual humans and sign papers with a ballpoint pen. Of course the real trick was getting to and from the office without being snatched by a passing dinosaur!
It’s a different, faster world today, and the rise of discount brokerage firms and the internet has changed the game for retail investors. We can check prices, do research, open and close accounts, and make trades from a device that fits in our pocket. And we trade stocks and bonds now for far less than even giants like Fidelity paid back in the dark ages.
It’s the same on the institutional and investment banking side. Fees are negotiable these days, and many firms will see downward pressure on banking fees and the fees associated with doing an IPO. Some firm like Google (GOOGL) and Spotify (SPOT) go public via direct listing and pretty much skip most of the IPO process.
Hedge funds are feeling the heat as well. Paying a 2% management fee and 20% of profits is okay when your manager is earning fees of 25%, 30%, or more every year as was often the case in the early days of the industry. Back then, exotic strategies like risk arbitrage, statistic trading, convertible arbitrage, and macro trading were not crowded fields, and the handful of folks who ran hedge funds were putting up eye-popping numbers and investors gladly paid the fees.
That’s not the case today. It’s much harder for large investors to gain an edge on the market. If it works, everyone jumps into the pool – but it just doesn’t work as well anymore. Hedge fund returns are now lucky to keep up with index funds in many cases, and fees are coming down for many hedge fund managers these days.
Falling fees means lower revenues. Lower revenues mean lower profits, unless you lower costs as a percentage of revenue. The quickest way to achieve that is to buy a smaller competitor and cut out the redundancies.
Fee pressure is going to lead to a consolidation wave among brokerage firms, investment banks, and asset managers for the next several years.
Profit off the Consolidation Wave in These Two Ways
There are two ways to make money off consolidation trends.
Here they are…
- The Story
The overall narrative I am presenting to you here involves takeovers of smaller businesses by larger competitors.
The target company is usually purchased at a premium to the current market price, and that can lead to some nice gains for investors that go in ahead of the deal.
The companies that do the best job of buying other companies and folding them into their business are going to see profits go higher and that can lead to enormous gains.
That is precisely what is going to happen in the investment business over the next decade or so.
- (Surprise, Surprise…) The Numbers
So now that we know there will be a consolidation trend in the industry, we should just run out and buy brokers, asset managers, and investment banks, right?
Not so fast.
Basing your approach on the story would probably work out okay, but as I said before, okay is not enough for me. While the consolidation story is solid and I am confident it will play out as I expect, the big money in stocks is made by listening to the numbers, not the story.
Once we are aware of the trend, we then wait for the numbers to jump off the page, do a happy dance, and run around in circles screaming “BUY ME.” Combining the tailwinds of the big trends with numbers that identify high-profit potential bargains are how the life-changing opportunities are found.
We already added one investment bank to our Heatseekers portfolio when the numbers began to dance. I fully expect we will add more companies like this soon, especially if the market continues to decline.
There is another group of stocks that will be resistant to the fee compression and consolidation trend, and these companies could make you as much or more than the consolidation theme.
But that’s a story for next week!