The recent fluctuations in the securities industry have been significant. A friend asked whether the securities industry has investment value and what the risks are.

What is the current valuation situation, is it suitable for investment?

The securities industry has seen a considerable increase recently.

Recently, there have been some positive news for the securities market. For example,

- On August 28th, the stamp duty was halved.

- On August 18th, the stock transaction handling fee was reduced.Stamp duty and handling fees are all part of the transaction costs of stocks.

If these costs are reduced, investors' trading costs will be lower, which is also a positive for the market and helps to increase the activity level of the securities industry.

Affected by these positive news, the securities industry has also seen a significant increase in the past two months.

Business model of the securities industry

How does the securities industry make money?

Overall, the types of businesses in the securities industry are quite diverse.Firstly, there is the brokerage business.

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We trade stocks and exchange-traded funds (ETFs) through securities firms, from which they can earn commissions and other fees.

In addition, common business lines of securities firms include:

- Asset management services: such as issuing various asset management products;

- Investment banking: such as assisting non-public companies to go public;

- Investment: for example, securities firms can invest with their proprietary capital, and so on.Different securities firms have varying levels of income from different businesses.

Some brokers are good at investment banking, while others excel in brokerage services.

However, no matter which aspect of the business, it is highly related to the prosperity of the market.

- When the market is doing well, the securities industry's profits are good;

- When the market is doing poorly, the securities industry's profits are poor.

Securities industry: a highly cyclical industry.It is precisely because many operations in the securities industry are highly correlated with the prosperity of the market, and the fluctuations in the A-share market are relatively drastic.

Therefore, the entire securities industry exhibits a very typical strong cyclicality.

For example, when offline account opening and offline trading were still common, it could be observed that:

- During bull markets, securities trading halls were bustling with activity, often requiring queues to open an account;

- In bear markets, the trading halls were desolate and quiet.

There was also a joke circulating in the stock market back then:

An old man who guarded a securities brokerage firm made money from stock trading.

Many people asked him for the secret to his investment success.The old man said, "I just look at the parking lot of the brokerage office. When there are no cars in the parking lot, I buy stocks; when the parking lot is full, I sell my stocks."

Although this is a joke, it also reflects the strong cyclicality of the securities industry.

Valuation of the Securities Industry

Generally speaking, assets with strong cyclicality are not suitable for valuation using price-to-earnings (P/E) ratios, as it can easily lead to the low P/E trap.

What is the low P/E trap?

The low P/E trap refers to a situation where investors mistakenly believe that a company's stock is undervalued because it has a low P/E ratio, not considering other factors that might indicate the company is actually overvalued or facing headwinds. This can lead to poor investment decisions, as the low P/E ratio might not accurately reflect the company's true value or future prospects.Price-to-earnings ratio = Market value / Earnings.

Some varieties have a relatively low price-to-earnings ratio, mainly due to a significant increase in earnings in the short term. If earnings then drop sharply, the valuation may also be passively increased rapidly in a short period of time.

This is the low price-to-earnings ratio trap, which usually appears in some varieties with strong cyclicality, such as the securities industry.

In the mid-to-late stages of a bull market, the earnings of the securities industry surge, and the price-to-earnings ratio is passively reduced, leading to the low price-to-earnings ratio trap.

The following chart shows the historical trend of the CSI All-Share Securities Index (code: 399975) and a comparison with the overall earnings situation of the securities industry during the same period.It can be observed that in 2015, the securities index soared, and the profitability of the entire industry also increased significantly during the same period.

At this time, although the market had already reached the bubble stage, the valuation of the securities industry would appear relatively lower due to the interference of high profitability levels.

This is the low price-to-earnings (P/E) ratio trap.

In such cases, the P/E ratio indicator becomes ineffective and cannot reflect the true valuation state of the securities industry.

In fact, when the P/E ratio indicator fails, one can refer to the price-to-book (P/B) ratio.Price-to-book ratio = market value / net assets.

Compared to earnings, the fluctuation of net assets is less drastic and not as easily distorted.

The fluctuation of the price-to-book ratio is also smaller than that of the price-to-earnings ratio.

As of August 16, 2023, the price-to-book ratio of the securities industry is 1.46 times.

Although it is not as cheap as the 5.4-star rating in 2022, it is still undervalued.

The two bull and bear markets of the securities industry over the past decadeThe chart below is the trend chart of the CSI All-Share Securities Index (Code: 399975) since 2012. It can be observed that over the past decade, the securities industry has gone through two bull and bear market cycles.

The bull and bear market cycles here are determined by whether they have reached an overvaluation.

▼The first bull and bear market cycle

From 2012 to 2014, the A-share market experienced the largest and longest bear market in its history. During these years, the performance of the securities industry was also relatively sluggish.By the second half of 2014, due to consecutive and intensive interest rate cuts, the market began to rebound, and the securities industry also experienced a dramatic upturn.

From a low point of less than 500 points, it soared to over 1,700 points in one breath, reaching an overvalued state.

By June 2015, after the market overall reached a 1-star rating, the valuation bubble burst, and it began to plummet rapidly.

The securities industry also began a multi-year decline.

In 2015, there was a significant drop; from 2016 to 2017, it experienced a slow decline.

In 2018, due to trade frictions, the market began to fall, and the securities industry continued to decline as well.By the end of 2018, with a 5-star rating, the securities industry had fallen to its historical lowest valuation.

▼ Second Round of Bull and Bear Markets

From 2019 to 2020, the market as a whole rebounded, and the securities industry also rose for two consecutive years.

In July 2020, the securities industry once again reached an overvalued state. This was the most recent instance of overvaluation in the securities industry.

Afterward, the securities industry experienced a prolonged decline for over two years.In 2022, during the 3.5 and 4-star periods, the valuation of the securities industry was close to its historical lows, but it did not reach the low levels seen at the end of 2018.

Since the second half of 2022, the valuation of the securities industry has gradually recovered from its lows, but it is still currently undervalued.

Characteristics of the Securities Industry

From the trend of the securities industry over the past decade, it is not difficult to observe the following:

During bull markets, the securities industry may experience significant short-term surges.If one can invest from a bear market to a bull market, it is highly likely to yield substantial returns.

However, when the overall market conditions are not favorable, the securities industry may experience a prolonged period of decline, potentially lasting longer than the broader market during downturns.

Before the bull market arrives, investment returns are likely to be less than satisfactory.

Additionally, the securities industry is characterized by significant volatility, with the annualized volatility over the past three years being notably higher than that of the CSI 300 index, which does not make for a pleasant holding experience for investors.

Therefore, the securities industry is considered a more challenging investment, typically not suitable as the mainstay of an average investor's portfolio.It is best to consider such types of investments after gaining some experience, and pay attention to controlling the proportion, generally not exceeding 10%-15%.

The securities industry is essentially a value-style investment.

If you lack investment experience and feel it is difficult to manage, you can directly consider value-style funds.

Or consider an investment advisory portfolio, which has already diversified the allocation of different styles, making it more worry-free and effort-saving.