Interactive Brokers: Leaving Peers In The Dust

Investment Thesis

Interactive Brokers (NASDAQ:IBKR) is a leading electronic broker with approximately 2.29 million cleared customer accounts in over 200 countries and territories. My thesis revolves around three key parts: Offering better services than peers, a strong client base, and a low-cost structure. Nowadays, it is very common to hear that a broker is offering a $0 commission on trades in the hope of attracting more clients. Although that works, I like IBKR's approach better. They offer clients what most other online brokers can't offer: access to trade in over 150 electronic exchanges, 25 currencies, futures, and more. Most of its peers only offer access to companies traded on the Nasdaq, NYSE, and OTC.

The client base of online brokers such as Robinhood, E-Trade, TD Ameritrade, and Charles Schwab is mostly if not fully, made up of retail traders only. That isn't the case for IBKR. The company's client base is composed of 55% retail and 45% institutional. These clients don't buy and hold; they are actively trading, and the company's low margin rate coupled with the platform's efficiency helps them retain those clients. The company's proprietary technology, coupled with its low-cost execution, helps it keep operating costs low, enabling higher margins than peers.

IBKR has one of the lowest cost structures in the industry, allowing it to offer clients low-margin rates and higher rates on uninvested cash.

The company is likely to benefit from the Fed's decision to hike rates, with plans to keep them higher for longer (5.1% by the end of 2024). IBKR's 4.83% interest on uninvested cash is higher than most peers and banks. This will incentivize clients to hold more cash in their brokerage accounts. The company earns interest income by investing cash in client accounts into U.S. treasuries and providing margin loans to clients. IBKR pays interest to clients for the uninvested cash and pockets the difference between the interest income and interest expense.

Company Description

Interactive Brokers specializes in handling orders, executing, and processing trades in stocks, options, futures, and more. The company operates in more than 150 electronic exchanges, market centers in 33 countries, and 26 currencies. IBKR ended the second quarter of 2023 with approximately 2.29 million clients in over 200 countries and territories. The company's clients include retail traders and institutions such as hedge funds, financial advisors, proprietary trading desks, and introducing brokers. Almost 62% of customers’ equity is in institutional accounts. The firm mainly derives revenue through trading commissions and net interest income.

As for the industry (equity trading), it experienced a huge revenue boost in 2020 due to more participation by retail investors amid the pandemic. IBKR was a prime beneficiary as its non-interest income increased by 57% and experienced a 56% growth in customer accounts. The company's main competitors include Robinhood, Webull, TD Ameritrade, E-Trade, Fidelity, Charles Schwab, and FUTU Holdings (international competition). Most of IBKR's peers aren't publicly traded; E-Trade was acquired by Morgan Stanley, TD Ameritrade by Charles Schwab, and Webull is owned by Fumi Information Technology.

Recent Development

IBKR's stock is up by 23% YTD, compared to 11% of the S&P 500 (SPY) as of this writing. The company reported second-quarter earnings in July. The company missed on EPS by $0.08 and on revenue by $57 million. Commissions per trade rose to $3.11 vs. $2.74 YoY driven by improved trading because options command higher commissions. Daily average revenue trades decreased 12% YoY, stock trading volumes fell by 28% YoY, and futures fell 4%. Option volume did experience a bump, rising by 9% YoY. Operating margin improved by 5% YoY. Additionally, The company recently expanded its overnight trading to over 10,000 US Stocks and ETFs.

Valuation

My bear case implies a price target of $71.40 by December 31, 2024, representing an EPS of $4.52 and a multiple of 15.80x, I estimate revenue to experience a growth of 36.65% in 2023, driven by an increase in interest income, before growing to 8.4% in 2024.

My base case implies a price target of $99.99 by December 31, 2024, representing an EPS of $6.13 and a multiple of 16.30x. I estimate revenue to experience a growth of 37.65% in 2023, driven by an increase in interest income, before growing to 9.4% in 2024.

My base case implies a price target of $131.37 by December 31, 2024, representing an EPS of $7.82 and a multiple of 16.80x. I estimate revenue to experience a growth of 38.65% in 2023, driven by an increase in interest income, before growing to 10.4% in 2024.

All the multiples used below are at a discount to the current P/E (17.09x) and five-year FWD average (20.64x) but at a premium to the current FWD multiple (15.18x).

Risks

Risks to my buy rating on IBKR include increased competition and regulations. In terms of competition, I don't think IBKR has too much to worry about with its peers offering similar rates, because most of them can't sustain it due to the high operating costs. Their platform isn't as scalable as IBKR's. The company has benefited from high interest rates, but once rates are low, the firm's interest income could decline, as will the low-margin loan rate, making it less attractive.

Takeaway

In conclusion, IBKR is a leading electronic broker offering better services than its peers. Personally, when I first started investing, I used Robinhood, but once I heard of IBKR's offerings, it was a no-brainer switch. I believe the company will still outperform its competitors, mainly due to its low-cost structure, which allows it to offer clients better margin loan rates and high interest on uninvested cash. My valuation implies a ~$100 price target by the end of fiscal year 2024, which translates into an ~18% return from the price of this writing.