For the sixth consecutive year, Interactive Brokers Group Inc. (IBKR, Financial) was ranked number one on the Best Online Brokers Review ranking compiled by the eminent finance newspaper Barron's.
And its list of awards is way longer than that; the company has a full webpage dedicated to them all, a sort of online trophy room.
This multinational brokerage firm was first created as a market maker in 1977. Its history is rich in innovation (e.g., it was the first to implement a fully automated algorithmic trading system in 1987). The Greenwich, Connecticut-based company has offices in 27 cities around the world.
Tangled societary structure and succession conundrum
With a presence in over 150 markets globally, the company provides a single platform to broker stocks, bonds, funds, exchange-traded funds, foreign exchange, options, futures, EFPs and some cryptocurrencies. Custody of securities, commodities, foreign exchange and automated trade execution are also integral parts of the business.
Interestingly, Interactive Brokers is not a bank. This is a fundamental aspect which needs to be highlighted since it comes with some limitations and provides some important strengths from an investor perspective.
Being a bank means a company can carry securities classified as held to maturity, which, from an accounting point of view, can be rewarding. HTM securities are not required to be marked to market on a bank's books. As such, not being a bank forces Interactive Brokers to daily reprice all its securities. Financial engineering is very difficult given this legal framework.
Sounds interesting and simple, but are there any drawbacks? Indeed, there is one. The corporate structure is tangled, to say the least.
To simplify, there are three entities involved:
- IBG LLC - the “real” company.
- Interactive Brokers Group Inc. - IBG Inc. for short - the publicly listed company that has 25.40% of membership interests in the former.
- IBG Holdings LLC, or Holdings for short, which owns the remaining membership interests - approximately 74.60%.
Here are a couple of visual clarifications, taken directly from the 2023 annual report (green and yellow colors added by the author for better interpretation).
Source: Official annual report.
As you may have noticed, this turned out to be a good thing. Founder effect is there to shield the Company. Thomas Peterffy, the founder and chairman of the board of directors, has the majority of the voting rights.
That is an enormous advantage since we can infer that all that has been done in the past, in terms of internal culture and risk aversion, may be repeated in the future with a high degree of probability. Results are never ever inferable from past performance. You cannot sleep soundly knowing that everything will be done to replicate past performance. But in this case, there appears to be evidence of good consistency.
Will there ever come a time when the founder leaves? There certainly will be, since he is 79. In 2019, he stepped down as CEO in favor of Milan Galik, aged 57. Galik has been with the company since 1990. He climbed the ladder from being a software developer to his current position at the head of the company.
The cherry on the cake may be the founder's son, William Peterffy, is currently a company director. He has already left his mark on Interactive Brokers, being responsible for the early implementation of an environmental, social and governance panel on the platform. This appeals to younger generations and aligns with the stakeholder culture rapidly spreading in the finance world.
Business segments
Interactive Brokers shifted from a market-making business to a brokerage over its decades-long history. The latter now accounts for 99% of revenue, while market-making is done only marginally for options in Hong Kong and India.
Sales are split in two main segments. The first, net interest income, is more dependent on national-level fiscal policy (the federal funds rate). The other, commissions, is in direct control of the company, hence it is a more stable account.
A grounded perplexity arouses regarding the former segment. Historical data is reassuring as half of sales came from that account even in the decade-long low-interest rate period. An economical explanation may be that lower rates spur higher euphoria in the markets, hence more trading, and more margin accounts, resulting in increasing net interest income.
During the last decade, net income has grown substantially with a real average of 37%. Prudently adjusted (i.e., stripping out the 122.4% growth in 2018), the number is still impressive at 27.50% per year.
Source: Author's chart from official numbers.
Impressive margins with stable financials
Interactive also has impressive margins. The gross profit margin has been improving over the past decade, with an average in the mid-60s. This is made possible due to the low capital expenditure model it has used since the beginning.
The company's balance sheet, however, reveals a double-edged sword. IBG LLC has no long-term debt. On one hand, this is great for equity investors as in the event of liquidation, they will get paid almost all the assets held. On the other hand, it can be detrimental to growth. No debt, especially given the former prolonged period of low interest rates, can be a terrible management mistake.
Looking beyond that, the current ratio (i.e., current assets divided by current liabilities) is well above parity, a good sign. And the company's pile of $3.70 billion in cash and cash equivalents not segregated for regulatory purposes is well above the necessary amount to cover the $17 million in short-term borrowings.
The management team emphasized that some acquisitions may be on the horizon, and that the $14 billion in equity is there to do just that.
For all this, and some more, the renowned rating company Standard & Poor's granted Interactive Brokers a phenomenal rating: A- with a stable outlook.
Comparative valuation
A comparative valuation is useful for analyzing the stock in this particular case. Regarding the operating margin, Interactive Brokers has a more juicy number versus TD Ameritrade (AMTD, Financial) and Charles Schwab's (SCHW, Financial) 40% to 50% and E-Trade's (ETFC, Financial) 40% to 45%.
The company is fourth for market capitalization in its industry (Finance - Investment Banking, even though it is not a bank), beyond behemoths Morgan Stanley (MS, Financial), Goldman Sachs (GS, Financial) and Charles Schwab.
Further, the average and median price-earnings multiples for the industry are 16.16 and 16.39, respectively. At 19.63, Interactive's earnings multiple seems overvalued currently. The number had been trending lower in previous years and was around 15 at the end of 2023. A declining price-earnings ratio may imply falling prices, but not in this case. Price-wise the picture is good. The stock has returned 315% since its initial public offering in May 2007, outperforming the S&P 500's 244% gain.
Its direct competitors, however, have been awarded much higher multiples. Charles Schwab has a price-earnings ratio of 23.37 and a price-sales ratio of 6.77. RobinHood Markets (HOOD, Financial) has no earnings to account for, but a price-saler ratio of 8.63.
At a price-sales ratio of 6.13, Interactive Brokers seems to have some way to go. But the 33% year-to-date performance is impressive, outpacing the major U.S. indexes by a factor 3. Will the run extend further?
Based on proprietary estimates made by GuruFocus, the stock appears to be modestly undervalued. It looks like it has some room to grow in the low-teen percentage points.
Conclusion
Interactive Brokers is expected to release itsquarterly report before the end of the month. Do not overlook it. Interactive Brokers is one of the best and more trustworthy brokers publicly traded, yet it still has little analyst coverage. Therefore, an opportunity may arise if results fall short of expectations.
