Why I Bought Interactive Brokers

Jul.19.12 | About: Interactive Brokers (IBKR)

During Wednesday's session, Interactive Brokers (NASDAQ:IBKR) had a rough time, after having missed the analyst earnings consensus Tuesday ($0.19 EPS expected, $0.17 reported). Interactive Brokers suffered both because of a currency conversion charge, and also because the market's trading environment has been kind of slow.

Interactive Brokers gets about half its earnings from being a discount brokerage, with 200,000 customer accounts holding $28.6 billion in equity. The other half comes from proprietary market making, namely in options.

So why did I buy Interactive Brokers Wednesday? For two reasons.

I Love the Product

I've been an Interactive Brokers customer since 2002. I've used its TWS (trading workstation) software for trading equities, futures, commodities, and forex for tens of thousands of trades on multiple worldwide markets.

I've also used many other trading systems in my career, and I never found anything that came close to Interactive Brokers' TWS and was available to retail traders, allowing for true real-time reactions to the market, speedy executions and reporting, low costs … everything only institutions had access to, not long ago.

In short, this motive was something similar to what Peter Lynch preached -- I love the product, so at a sensible valuation I am a buyer. I believe that Interactive Brokers, having such a powerful product, should be able to conquer the most active traders out there little by little. Indeed, it should even be able to conquer many hedge funds. That Interactive Brokers tends to cater to the more active/better funded trader community is already evident in its $143,000 average account size.

Sensible Valuation

I had looked at Interactive Brokers many times in the past, since I didn't start loving the product today. But until this point, the valuation was too stretched for me to consider buying.

Not so now. At $13.32 -- where I bought it -- Interactive Brokers trades at a forward 2012 P/E of 11.9 times. Given its $0.10 quarterly dividend, it carries a dividend yield of 3.0%, which should lend it some support during this phase when it's seeing some downward pressure to its earnings estimates due to the slow trading environment.

Is It All Positive?

Not at all. Interactive Brokers' product is only appropriate for the advanced trader. There's not that much hand holding, and the system itself is complex given the capacity it puts in the trader's hand. On the same TWS page, the trader can easily be trading equities, futures, forex, commodities -- all at the same time. On one hand, that's incredibly powerful; on the other hand, it can get confusing for novices, with all the necessary configuration of data sources, trading permissions, etc. This can mean that the addressable market is limited only to those traders willing to put in the time to understand how everything works.

Also, there are better alternatives in the market regarding automatic trading, even though Interactive Brokers' API is quite fast. Once again, only very advanced traders with considerable programming skills will be able to explore this capacity -- others will probably need to find automatic trading capabilities elsewhere. Again, this can limit the addressable market.

Finally, the slow trading environment that's been punishing Interactive Brokers' earnings can stay with us for a while, limiting upside. Also, generically it's a bad idea to buy so close to a stock having provided a negative surprise (like Interactive Brokers' earnings miss).

Conclusion

While there are negatives as well as positives, me loving the product and the sensible valuation Interactive Brokers trades at right now was enough to prompt me into buying the stock.

Disclosure: I am long IBKR.