Interactive Brokers: Big Profits From Volatility (NASDAQ:IBKR)

No one can say for sure where the market will go in the near term, and no matter what, nearly everyone may agree that there will be plenty of volatility along the way. A good way to hedge against market volatility is to buy stocks that benefit from volatility itself.

One such firm that stands to benefit from this is Interactive Brokers (NASDAQ:IBKR). With plenty of market ups and downs over the past few years, IBKR has continued to benefit. This is reflected by the 34% total return it’s provided since my last bullish take on the stock in late 2020, far surpassing the 10% return of the S&P 500 (SPY) over the same timeframe . In this article, I highlight why IBKR is currently a Buy for long-term growth investors.

Why IBKR?

Interactive Brokers Group is an online broker that’s widely used by professional traders and retail investors alike. It provides automated trade execution on securities, fixed income, commodities, and foreign exchange on a 24/7 basis to over 150 markets across 33 countries and 26 currencies with a single, integrated investment account, providing ease and simplicity to its clients. It has 2.0 million client accounts and $287 billion worth of client equity under custody.

IBKR’s key competitive advantage is its aforementioned global reach and investments in technology to enable high speed execution. Its built-out platform and scale results in diminishing costs, and is reflected by its strong gross profit margin of 88%, which is well in excess of the 64% sector median.

Meanwhile, IBKR continues to benefit from global volatility, as commission revenue increased by 3% YoY to $331 million during the fourth quarter. This was driven by higher customer futures trading volume and large average trade size in options, partially offset by lower customer stock trading volume.

This makes sense as the fourth quarter was largely a down market for most stocks, with many investors utilizing options to bet where they believe the market is headed in this new year. Moreover, IBKR is largely benefitting from higher interest rates as net interest income rose by 92% YoY to $565 million. Importantly, IBKR is seeing strong new customer acquisition, as total accounts grew by 31% YoY to 2.0 million.

Looking forward, IBKR is well-positioned as it continues to offer the lowest U.S. margin rates compared to its large brokerage peers, with rates ranging from 3.6% to 4.6% for IBKR Pro. IBKR also doesn’t spend a substantial amount of capital on marketing like its peers, as most of its account growth is by word of mouth. Management estimates that accounts grow at a 10% annualized rate during down markets, and 20% during up markets.

Moreover, the first quarter of 2023 is lookup up from a market performance standpoint, which bodes well for IBKR’s common equity trading volume this quarter. Management is also upgrading its platform by adding new products and aims to maintain its lead in the options market, as noted during the recent conference call:

We are at the cutting edge of this best execution through auction process. We were the largest market makers in options for over 30 years, so we are very well-versed in these processes, and we have been keeping them up to date over the years. With the potential for a new regulatory process, in addition to new exchanges and continuously evolving new rules, we have a team of programmers regularly engaged in this activity.

We introduced more new products and expanded the capabilities of existing ones. Recognizing our global customer reach, we introduced GlobalTrader, a streamlined version of our platform for mobile devices, which allows our clients to trade in over 90 stock markets worldwide. We continue to enhance our options trading tools, from mobile options trading to our rollover options tool, Strategy Builder, and Probability Lab.

Importantly, IBDKR carries a very strong balance sheet with $3.2 billion in cash and equivalents with no long-term debt, and over 99% of its balance sheet is comprised of liquid assets. Management is also highly aligned with shareholders, with a 76% ownership stake in the company, which is very high for a publicly-traded company.

Lastly, I see value in the stock at the current price of $77.51 with a blended PE of 18.6, sitting well below IBKR’s normal PE of 26.7. Analysts have a consensus Strong Buy rating with an average price target of $102, translating to a potential one-year 32% total return.

Investor Takeaway

Interactive Brokers is by far the most innovative broker in the industry, and continues to benefit from its strong global reach, platform upgrades, and efficient low cost structure. It’s seeing strong customer account growth due largely to word of mouth, and should continue to benefit from market volatility and high interest rates. It also carries a strong balance sheet and has high alignment of interest with shareholders. Lastly, I see value in the stock at the current price for potentially strong long-term returns.