The World's Best Broker

Friends, Fools, countrymen, lend me your ears;
I come to bury the discount brokers, not to praise them.
The good that they do can be read in any of their banner ads;
Butthe evil that they do has ruined many a portfolio.
-- Julius Caesar, Act III, Scene 2 (revised translation)

OK, I've taken a few liberties with the immortal words of the Bard. But trust that it's for a good cause. Online brokers are "dead to me" (do you like the theatrics?), and it's high time someone buried them for the wrongs they're doing to investors' portfolios. But before we get to the interment, let's review the good, the bad, and the ugly (truth).

The good
Discount brokerages have made it affordable for the individual investor to dabble in stocks. Buying a stock used to be a leap of faith. Back when it cost $300 in commission fees to buy 1,000 shares, you had to be pretty darned convinced that the investment would pay off, because you were starting off $300 in the hole. But with discount brokerages such as TD Ameritrade, E*Trade, and Sharebuilder now engaged in an endless game of "how low can you go?" with commissions, investing has become affordable to the Everyman.

The bad
But that raises this question: How was an industry that once felt the need to charge hundreds of dollars per trade in order to make a decent profit able to switch to $5 and $10 commissions and still stay in business?

The answer: volume, baby.

If a broker can get those traders trading multiple times a week, then even if he's making just a few dollars on each trade and a few pennies per share from the bid/ask spread, it all works out just fine on the income statement. And the way the brokers keep the traders trading is to make the whole investing process exciting. Bright green tickers for rising stocks. Glowing red tickers for short candidates. "Live, streaming quotes!" And a "Command Center" to watch over all the action.

But lost in all the excitement is one crucial fact: These aren't just tickers streaming by. These are stakes in real companies -- businesses that struggle and prosper quite independently of how their stock prices fare. When your online broker tells you that last Friday, Cisco Systems ended $0.42 above its Thursday closing price, or that Time Warner (NYSE: TWX  ) dropped $0.11, you haven't really been told much. You don't know whether the change in price made either company a more or less attractive investment. Still, the movement of the numbers may motivate you to "take profits" on your shares of Cisco, or to "back up the truck" on Time Warner. And that, of course, is the broker's objective.

The ugly truth
What the online brokers do with their Technicolor ticker lists is just a high-tech variation on the cold calls that offline brokers used to make. By quoting companies' minute-by-minute price movements, they play on your emotions and encourage you to trade more often. It's a strategy calculated to enrich the broker -- not you.

A Fool's wish
How much better -- and more Foolish -- it would be if brokers told you not just a stock's price change, but the changes in its valuation over time! I imagine a portfolio tracker looking something like this:

Company

Current P/E

Current ROE

Year-ago P/E

Year-ago ROE

Time Warner

24.9

5.1%

26.5

5.6%

Motorola (NYSE: MOT  )

12.5

30.3%

19.1

18.0%

Micron Technology (NYSE: MU  )

66.1

2.7%

29.6

8.1%

Sun Microsystems (Nasdaq: SUNW  )

N/A

(7.9%)

N/A

10.8%

Yahoo! (Nasdaq: YHOO  )

26.1

23.7%

53.8

16.0%

NVIDIA (Nasdaq: NVDA  )

37.7

23.0%

33.0

9.0%

Applied Materials (Nasdaq: AMAT  )

28.7

11.8%

18.4

17.8%

Data courtesy of Capital IQ, based on trailing-12-month results. "Current" ROE data uses most recent calculations available.

This is just a working model, of course, but it would be far better if our brokers gave us information like this -- instead of a bunch of ticker trivia -- right from the get-go. I mean, without knowing anything else, I'd take a look at buying Yahoo! and selling Micron given the above information. While those may not be the right moves, the decisions are better informed than they would be if I only knew the stock price.

Of course, that will never happen. If investors got in the habit of leaving their portfolios alone for months at a time, the brokers would die of commission withdrawal. Still, there's no rule compelling you to play the brokers' game. You can choose to ignore the online scorecards and their pretty colors. You can instead learn to patiently and consistently build wealth through thorough research before buying, and occasional checkups thereafter. At Motley Fool Stock Advisor, we can help. Before recommending an investment, we research it completely, then lay out our investing thesis for you to review. Subsequently, we update you on important news twice a month, and conduct a thorough re-evaluation every six months of every stock in our portfolio.

This approach to investing (slow and steady) has saved Fools countless hours -- and countless commission dollars they might otherwise have spent trading into and out of stocks based on meaningless, short-term pricing movements. Not coincidentally, it's helped our portfolio trounce the S&P average by more than 40 percentage points during the past four years. Sound too good to be true? Don't take my word for it: Click here and check out our performance for yourself.

This article was originally published Jan. 10, 2006. It has been updated.

Fool contributor Rich Smith has no position in any of the companies mentioned in this article. He discloses this because The Motley Fool would requires him to tell you so. We're sticklers about things like that. Time Warner and NVIDIA are Stock Advisor recommendations.


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