Finding investment returns when the stock market is volatile could be as simple as asking one question: Which companies benefit from volatility? Online financial brokerage firm Interactive Brokers (IBKR) certainly fits the bill.
The company offers clients an opportunity to invest in thousands of financial instruments, and when market gyrations are particularly large, trading activity tends to spike. Since Interactive Brokers earns commissions on those transactions, its business does well in volatile conditions.
The Nasdaq-100 technology index has declined by 29% this year whereas Interactive Brokers stock is performing far better with a loss of just 2.6%. And in the last month, its stock has soared by nearly 20% thanks to better-than-expected financial results for the third quarter of 2022 (ended Sept. 30). Here’s why it might continue to outperform.
New customers are flocking to Interactive Brokers
Financial markets soared during 2021, which spurred interest from many first-time investors, and it led to one of the strongest years ever for Interactive Brokers. With such heavy losses in 2022 (broadly speaking), it would be natural to assume people would now steer clear of the markets — especially as the cost of living is rapidly increasing, which leaves consumers with less investable income.
But that wasn’t the case in the third quarter. Interactive Brokers saw a whopping 31% increase in the number of client accounts year over year, to 2.01 million. It appears those clients were also more willing to make risky bets, with trading volume on futures contracts soaring by 37% whereas volume in direct equities (stocks) fell by 56%. But for Interactive Brokers, that’s not a bad result because it earns significantly more commission per transaction on the former.
Client equity, which is the amount of cash and financial assets held with Interactive Brokers, fell 19% year over year to $287 billion, but that’s mainly due to the stock market’s steep decline in value in 2022. Typically, a fall in client equity would lead to a fall in revenue for Interactive Brokers because its fee base becomes smaller, but the drawdown was offset by the surge in new accounts and increased net interest income, so that wasn’t the case.
Interactive Brokers offers credit and margin lending to clients, which allows them to borrow money to buy more financial assets. Interest rates have been rising throughout 2022, which benefited the company, leading to a jump in its net interest margin to 1.67% in the third quarter, from 1.13% a year ago.
Interactive Brokers’ financial results soared in Q3
The increase in Interactive Brokers’ net interest margin led to a whopping 73% year-over-year increase in its net interest income during the quarter, to $473 million. It helped push the company’s overall revenue to $790 million, up 70% compared to the year-ago period, and it marks the highest result of 2022 so far.
Interactive is a highly scalable business, so its fixed costs don’t rise a great deal when its business grows. That means when it has an influx of new customers and its revenue soars, much of that benefit flows through to the bottom line. As a result, the company’s earnings per share (profit) more than doubled to $0.97 in the third quarter.
Interactive Brokers stock might continue to outperform
Based on Interactive Brokers’ trailing-12-month earnings per share of $3.10, its stock trades at a price-to-earnings ratio of 24.7. That’s a slight premium to the Nasdaq-100 index, which trades at a ratio of 23. But remember the index has lost 31% of its value this year.
Interactive Brokers stock is still attractive on a relative basis, especially since its revenue and earnings are currently accelerating while many other companies — particularly those in the tech sector — are experiencing a slowdown and slashing their forecasts for the future.
This company should continue to benefit from its two key tailwinds right now. First, the stock market is likely to remain volatile for the rest of this year. But even if it recovers, Interactive’s clients should experience a lift in the value of their account equity, which would increase the company’s fee-earning potential. Second, interest rates are expected to remain elevated into 2023, which will buoy Interactive’s net interest income.
Overall, not only does the stock have the potential to rise from here, but it’s also likely to offer protection to investors if the broader markets deteriorate even further. The company has the potential to perform even better in that environment.
— Anthony Di Pizio
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Source: The Motley Fool