Interactive Brokers is a low-cost operator in the massive brokerage market that's been consistently taking share from the larger players. Meets all Buffett's criteria for an 'attractive investment situation' from a letter: One positive aspect of the global market volatility in recent weeks has been the ability to pick up shares in long-term growth compounders at reduced prices.
Interactive Brokers is a fully-automated electronic broker and market maker. It is the only truly global investing platform, allowing clients to trade in 24 countries as well as EU products at hundreds of market centers, with support for 19 currencies and 9 languages, all from a single account. The company was founded in by Thomas Peterffy, who remains the CEO and majority shareholder while overseeing all aspects of the business. In the interim decades, he built the company from a single-seat AMEX market maker to a multi-billion dollar brokerage business that processes over M trades a year.
IBKR operates two lines of business - market marking and brokerage - with very different outlooks. However, the company's brokerage business is a veritable juggernaut that continues to grow rapidly and take share from competitors.
Because it represents the majority of the company's value, this writeup will focus mainly on this larger and more attractive segment in terms of the industry outlook and business quality. As discussed below, the bifurcation between divisions here is part of the reason this opportunity exists today.
The brokerage industry is both massive and highly fragmented, with countless firms competing for client assets. These firms range from high-touch, established firms like Fidelity that have a mostly older customer base to app-based startups that automate the whole investing process like Betterment and are geared primarily to millennials.
While the desired amount of one-on-one interaction and customer service varies greatly among individuals, one thing that all investors agree upon is the preference, all else equal, for lower costs. This demand first manifested itself in the products being traded hence the consistent inflows to virtually fee-free index funds for several decades , but is now starting to show in trading services and execution as well see charts below. This trend strongly benefits IBKR, as they are - by far - the low-cost leader across all brokerages in both commissions and margin loan rates:.
While the US market is fairly saturated in terms of the aggregate number of accounts, a number of international markets still have strong growth prospects. The most notable of these is the Asian-Pacific market, where the rise of the middle class is facilitating increased demand for both bank and brokerage accounts.
Asia is a particularly lucrative market for brokerage firms, as individuals in many of its constituent countries tend to trade their stocks more frequently see below and thereby generate more commissions, and IBKR's international reach gives it the advantage in penetrating this market opportunity. Brokerage firms in general often have attractive business models thanks to their fixed-asset-light nature, but even in its peer group, IBKR stands out from the rest. From its beginning in the s, IBKR has always been a tech-focused company striving to use automation to reduce expenses and then pass those savings on to clients.
The technology team is filled with MIT Ph. As a result, IBKR has developed best-in-class processes that allow for not only the lowest costs, but also the best execution. As such, it's perhaps not surprising that IBKR has been consistently taking market share from the larger players:. SCHW experienced system failures due to heightened activity during market volatility.
Then again, maybe that's what these companies should expect when they hire English majors nothing against them, but not exactly a technical degree to head investment platform technology like at TD Ameritrade NASDAQ: AMTD - particularly when these individuals seem to have their minds elsewhere during the market volatility in the past weeks:. I also think that producing bizarre videos is a poor use of a 'technology' executive's time, but maybe that's just me.
A former Hungarian emigrant, Peterffy has spent his entire professional life building IBKR into a multi-billion dollar company over which he still maintains control.
As the majority owner, his interests are very much aligned with shareholders, and over the years, he's shown himself to be a talented operator and disruptive innovator. All in all, I'm very comfortable investing alongside him. Another reason for comfort and another manifestation of management prudence is the company's fortress balance sheet and general financial strength.
Virtually all of their assets are liquid, and the company has no long-term debt. I believe there are two main reasons why investors can buy IBKR at its current attractive price.
First, despite rapid growth in recent years, the company remains just a fraction of the size of larger firms. This won't always be the case - the company has publicly set a goal of becoming the largest broker by profits - but by the time IBKR has caught up, I suspect many more investors will have the company on their radar. As a result of these reduced trading volumes, the company receives much less analyst coverage than peers IBKR is covered by 4 analysts, vs.
IBKR's brokerage and market maker divisions are in very different points of their lifecycles, so I think it makes sense to value the business using a sum-of-the-parts, with the majority of the value embedded in the brokerage business.
Sometimes it makes sense to pay up. Checking the financials appears to show a rising share count, but a closer look reveals that this is simply one of the controlling LLCs exchanging common shares for ownership interests so the rising share count is offset by a great percentage of the company being owned by the public.
For the rest of the business the market maker I simply value it at book, which is a conservative estimate of its runoff value. While this is attractive in its own right, remember IBKR will continue to compound intrinsic value for many years to come - a buy and hold investor's dream. There is also significant upside potential from my target price if: I see several potential catalysts that could drive shares higher in upcoming months:.
After years of falling volatility, thanks in part to consistent QE see chart below , we've finally seen market volatility levels rebound higher in Heightened volatility in the markets has two beneficial effects on IBKR.
The first is increased profits in its market making segment as general transaction demand increases. The second is that it makes the company's position as the low-cost brokerage leader all the more important to clients - heightened activity drives larger commission expenses that put the differences in commission rates into stark contrast. The possibility of a rate hike from the Federal Reserve later this year is a clear positive for IBKR, as it will widen spreads and allow the company to substantially increase its net interest income NII.
Many of their peers pad their profits by selling their order flows to HFT firms, rather than sending them directly to the exchanges like IBKR. However, in the past year with the release of the book Flash Boys as a catalyst , regulators have begun closely examining this area. While thus far no major changes have occurred, any additional efforts to restrict the industry could negatively affect peers from either a publicity or profitability standpoint.
As CEO Peterffy discussed in a conference call last year:. Potential to Raise Pricing - while I think this is unlikely, IBKR could more than double its margin loan and commission rates and still be the lowest-cost provider. Were they to ever do that, this marginal revenue would fall almost completely to the bottom line.
Continued Outperformance Relative to Peers - this is more of a long-term catalyst, but if IBKR continues to outperform peers to the extent they have in recent years and I think they will , investors won't be able to help but to take note of it:. If you aren't convinced by the thesis laid out above, take it from the Oracle instead:. I always have been attracted to the low cost operator in any business and, when you can find a combination of i an extremely large business, ii a more or less homogenous product, and iii a very large gap in operating costs between the low cost operator and all of the other companies in the industry, you have a really attractive investment situation.
IBKR fits Buffett's description above almost perfectly, as: Accordingly, I think he'd agree the situation here is really attractive. This will drive increased awareness over time, which in turn should cause the stock to trade closer to its fair value. Between its deep moat, great management, and conservative capitalization I think the downside is very well protected here, while the huge market opportunity makes for strong upside potential.
As such IBKR is one of my highest conviction ideas today. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it other than from Seeking Alpha.
I have no business relationship with any company whose stock is mentioned in this article. Summary Interactive Brokers is a low-cost operator in the massive brokerage market that's been consistently taking share from the larger players.
Best-in-class technology combined with rapid growth makes this a classic GARP investment. Intro Interactive Brokers is a fully-automated electronic broker and market maker. Want to share your opinion on this article? Disagree with this article? To report a factual error in this article, click here. The chat platform is currently undergoing maintenance.
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