Interactive Brokers (NASDAQ:IBKR) is a company I’ve been writing about a few times over the past 6 months. Investing in brokers is a play on overall stock market activity. The result of this is that during market dips, things are going to go down.
As expected, we’ve seen both earnings and revenues drop to forecasts/expectations during early 2022 – and that’s what we’ll work on here, to see at what valuation we could buy IBKR.
IBKR – Recent results
When markets grow chaotic, companies like IBKR are bound to see chaos in earnings. In 1Q22, this was exactly what happened to this company. We’ve seen global humanitarian, inflation, supply chain, and shortage issues that we haven’t seen for years, with inflation that we haven’t seen since before I was born in the 1970s.
The company believes inflation is here to stay with us for some time, and in this environment, my tendency is to agree.
Persistent deficit spending in this country has limited the government’s ability to respond to high inflation with high interest rates. As for each 1% rise, interest on U.S. debt increases by $300 billion as it gets refinanced. So inflation is likely to stay with us. Few markets were unaffected by these events and most market indices worldwide were down in the first quarter.
(Source: IBKR 1Q22 Results, Nancy Stuebe)
Now, despite this, and despite all the market activity we’ve seen, the company has actually seen account and customer growth. On a YoY basis, the company has seen almost half a million new customers since March 2021, with significant account growth not from NA, but particularly in Europe and Asia, which means the company is growing internationally.
In particular, IBKR saw continued strength in options volume, with average daily options volumes of 42 million. The company is also seeing significant interest from new client groups. With an average customer ag of 42, the company is seeing new segments of customers above 50+ and with high amounts of wealth. Because people are getting more and more friendly with online activities.
The company is seeing an increase in exactly this type of customer.
Fundamentally, IBKR has seen a growth in its capital base during the first quarter, total equity of $10.5B which is up $1B YoY. Commissions were strong, up to $349M YoY, with options and futures up at least compared to 1Q21, but not to 4Q21.
Net interest income is improving. In some ways, this company is a net beneficiary of increased overall interest rates. Margin loan interest is already up – but while this goes up, securities lending revenues were down, and are going down due to fewer opportunities. Also, market data fees are up, and risk exposure fee revenues are up. So while NII is up, the company is seeing increased expenses which are impacting the EPS we’re seeing, causing drops for the company.
Primarily, these expenses come from execution, clearing, and distribution costs. Futures volumes were up, and these carry higher overall expenses and fees. Despite some of these increases, the company maintained a 64% continued pre-tax margin – which is close to industry-leading in this segment.
The company also retains one of the strongest balance sheets out here for the sector, with $114B on the sheet, and no long-term debt next to over $10B in equity capital.
While the company views its results as strong, with a strong start to the year, this is only true in context to the market performance. Growth rates are better than they were prior to the pandemic. The reason the company isn’t accelerating shareholder returns at this time, is that they want to use the equity capital (again, over $10B), to attract hedge fund prime business opportunities, which carry required balance sheet sizes. Until the company has secured businesses such as that, it’s unlikely the company will do things like massively increasing the dividend (if they indeed do this in the near future).
The near-term still shows risk. Company DARTs are down 10% M/M in April, which was after the company’s 1Q22 report. This means that we’re seeing a somewhat slowing trend in overall growth.
However, it’s important not to equate this slowing growth with fundamental risk. This broker is really doing well in most contexts despite not meeting the targets for the last quarter. IBKR is focusing on scaling its services, with the goal of being able to service 10 million accounts, at 10 million trades per day.
This is a target the company is getting closer to reaching.
The company is also focusing on retail investors, with a focus on servicing financial advisors. The company is trying to make it easier for these customers to onboard their clients for IBKR. Institutional accounts are growing as well, introducing broker accounts, with already some institutional customers being onboarded in 2022.
The company is also working on redesigning its apps and programs.
We are working on a facelift of our MobileTrader. We are designing a brand new desktop trading platform. And I could go on, we are going to be adding products as we usually do. We are going to be adding new geographies for our international traders.
(Source: IBKR 1Q22 Results, Milan Galik)
In short, despite missing some estimates, the company is doing very well, and the current price action in the stock is actually very much contrary to what the company is delivering in terms of earnings, or overall forecasts.
Let’s look at valuation.
The company is, as I said, experiencing price movement in a direction completely contrary to its earnings estimates, forecast and growth history. IBKR is expected to grow earnings by 16% annually until 2024 on average. These forecasts come in with a volatile degree of certainty, this is entirely true, but most of the missed forecasts are as far back as 2009-to 2016.
Let me instead put the case like this.
If at any time during the past 15 years, you invested in IBKR when the company was trading at close to 15X P/E as it is now, your returns would have been positive, regardless of when that investment was made.
Regardless of when.
The company’s long-term performance is absolutely solid.
If we have the foresight to recognize overvaluation historically as well as going forward, those RoR can be even higher. I view it as far more difficult to recognize overvaluation than undervaluation in a business like this – as you can see, during good times, this company can rise as high as 40-48X P/E. Me, I would probably call it a “SELL” when it reaches above 27X P/E.
Investing at 15X-18X P/E or below, and selling above 26-27X P/E would historically have given you fairly good returns on this investment.
The yield obviously isn’t great. It’s below 1% at this time, and don’t expect it to rise. At all.
Forecasts call for the dividend to remain completely static here until 2024 at the very least. Any growth you get from this company is likely to be capital appreciation, not so much yield. Thankfully, even on the basis of 15-18X P/E, there’s plenty of capital appreciation to be had here.
Considering a valuation up to 20X P/E or so, which is a fair premium for this business, calls for upsides of around 27-28% annually.
So there’s plenty of upside to be had here, even at conservative valuations and forward considerations. Unless the markets die down or dial back, this company is likely to continue performing well – and I don’t see that happening, even if we do go into a recession.
Now, I view S&P Global analyst targets as not being properly updated for the new market situation. 6 analysts give the company targets of between $90 – $121, with an average of $99/share.
That’s a 71% upside, which represents more than a 25X P/E. I don’t view this as being a valid target for the long term. I’ve been at a “HOLD” for a long time here, but now I’m switching my valuation.
I viewed IBKR as a “BUY” at $65/share – I maintain this price target, which means that I’m switching my target for this company.
It’s now a “BUY” with a decent upside to an 18X P/E – and no more than that.
IBKR for me is a now a “BUY” due to:
- Company fundamentals now indicate alpha-like outperformance on a 15-18X forward P/E basis.
- IBKR has significant advantages to most of its peers thanks to international availability, high degrees of automation and good plans for future growth both domestically and internationally
- IBKR is still a “BUY” here. The company is now below my overall price target of $65/share, and I see no reason at this time to lower the company’s price targets, even with the environment we’re going through.
Remember, I’m all about:
1. Buying undervalued – even if that undervaluation is slight, and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn’t go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
This process has allowed me to triple my net worth in less than 7 years – and that is all I intend to continue doing (even if I don’t expect the same rates of return for the next few years).
If you’re interested in significantly higher returns, then I’m probably not for you. If you’re interested in 10% yields, I’m not for you either.
If you however want to grow your money conservatively, safely, and harvest well-covered dividends while doing so, and your timeframe is 5-30 years, then I might be for you.
IBRK is currently in a position where #1 is possible in my process, through #3 and #4.
Thank you for reading.