Market makers, exchanges, and brokerages (KCG, IBKR, etc.)

Here’s how the market making business generally works:

Market makers pay exchanges money in return of special trading advantages over everybody else.  Then they use these special advantages to fleece the exchange’s other customers (mostly institutional clients).

Retail brokerages can route their clients’ orders to an exchange, to an off-market venue, or to their own market making division.  Retail investors still get fleeced… just not on an exchange.  Knight Capital Group (KCG) was one of the pioneers in fleecing retail investors.  They would buy order flow from companies such as Etrade and use the information to gain an edge.

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Tracking John Malone (Part 4) – Live Nation (LYV)

Liberty Media continues to buy shares of LYV on the open market.  I don’t see crazy undervaluation at LYV, though there are a few things about the company that stand out to me.

  1. The accounting is misleading.  Live Nation has lots of non-cash depreciation and amortization charges that deflate earnings.  Its stated depreciation is excessive.  Its true earnings might be somewhere around $120-150M/year.  This suggests an adjusted P/E ratio of around 16-20 (at $12.69/share).
  2. This company is leveraged.  If you account for the debt, its valuation seems a little rich.
  3. Live Nation seems to be a bet on innovation increasing its earnings.

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Retail and reversion to the mean

In investing, some people often make the argument that the profitability of a company will move away from the extremes towards the average of its (public) peers.  I see it often on  For example, this writeup on Aeropostale argues that Aeropostale’s profitability should trend back towards its past.  I think that this is a dangerous and flawed argument.

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Nanocaps: why I don’t like them

Nanocaps are stocks with a market cap less than $50M.  (To be honest, I used to think that the correct term was microcap.)

There are two main reasons:

  1. The overhead of being a publicly-listed company is going to be a huge drag on performance.
  2. Often these stocks are intentionally created knowing #1.  The brokers know that shareholders will have a hard time making money but they don’t care.

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