Has Interactive Brokers Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Interactive Brokers (NASDAQ: IBKR  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Interactive Brokers.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

(2.9%)

Fail

 

1-year revenue growth > 12%

(5.5%)

Fail

Margins

Gross margin > 35%

78%

Pass

 

Net margin > 15%

3.8%

Fail

Balance sheet

Debt to equity < 50%

101.7%

Fail

 

Current ratio > 1.3

1.17

Fail

Opportunities

Return on equity > 15%

11.1%

Fail

Valuation

Normalized P/E < 20

NM

NM

Dividends

Current yield > 2%

2.6%

Pass

 

5-year dividend growth > 10%

NM

NM

       
 

Total score

 

2 out of 8

Source: S&P Capital IQ. NM = not meaningful; Interactive Brokers had negative normalized earnings and started paying a dividend in 2011. Total score = number of passes.

Since we looked at Interactive Brokers last year, the company has given back all of its three-point gains from 2010 to 2011. The shares haven't done quite as badly, but they've still only managed to trade flat over the past year.

Interactive Brokers is a discount broker that caters to high-volume traders. With its rock-bottom per-share commission structure, it manages to undercut even commission rates of $10 or below from Schwab (NYSE: SCHW  ) , TD AMERITRADE (NYSE: AMTD  ) , and most other well-known online-based discount brokers. It also makes markets in certain areas, adding to revenue by providing market liquidity.

But it's been generally a tough environment for brokerage companies. Low interest rates limit their income from customer deposits, and general skepticism about the stock market has reduced trading volume. In November, for instance, Interactive Brokers reported an 8% year-over-year drop in daily average revenue trades. Moreover, on the market-making side, risks abound, as the recent episode with Knight Capital Group (NYSE: KCG  ) revealed all too clearly.

One area where Interactive Brokers has excelled is in margin loans. Charging margin rates that currently start at 1.66% for loans of $100,000 or less and go even lower for larger balances, Interactive Brokers has far cheaper financing than Schwab or TD Ameritrade, as well as E*TRADE Financial (NASDAQ: ETFC  ) , Fidelity, and Vanguard.

Still, for Interactive Brokers to succeed, it needs to convince would-be investors that the market is the best place to put their money. That's a tough sell at the moment, and until a big economic recovery makes ordinary Americans feel wealthy again, Interactive Brokers will struggle to get closer to perfection.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

No matter which broker you use, the best investing approach is to choose great companies and stick with them for the long term. In our free report "3 Stocks That Will Help You Retire Rich," we name stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.

Click here to add Interactive Brokers to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.


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