Interactive Brokers Group, Inc. CEO Explains the 'Magic' of His Business

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Motley Fool Stock Advisor senior analyst Jim Mueller and analyst Brendan Mathews recently traveled north to tony Greenwich, Conn., to interview Thomas Peterffy, CEO and founder of Interactive Brokers  (NASDAQ: IBKR  )  — and now they're sharing their interview with Fool.com readers. 

In this interview, you'll learn why Peterffy, a billionaire entrepreneur and executive, still considers himself a computer programmer at heart. He describes the "magic" that allows his company to offer investors rock-bottom trading costs while generating a 50% profit margin. 

He gives his thoughts on high-frequency trading, and he tells shareholders the most important thing they need to know about his company. Don't miss it — scroll down to read the transcript of their interview.

BRENDAN MATHEWS: This is Brendan Mathews and I'm lucky enough to be joined by Thomas Peterffy, the CEO and founder of Interactive Brokers. Thanks for joining us today.

THOMAS PETERFFY: Well, thank you for giving me the opportunity to speak to you.

BRENDAN MATHEWS: Thomas, for those that don't know your company, which has been a recommendation of ours for some time, could you just describe your company and what you think is special about your business?

THOMAS PETERFFY: Well, we are an electronic broker-dealer. We specialize in catering to customers who are financially sophisticated and our specialty is very low transaction costs and very good executions. We are usually lumped in with other direct access brokers such as Schwab and Ameritrade, but what distinguishes us is that our customers are usually more sophisticated than theirs. They tend to manage more money and they care about very low transaction costs and very good executions.

BRENDAN MATHEWS: So, as CEO, setting aside sort of GAAP financials, what are the two to three operating metrics that you're really focused on?

THOMAS PETERFFY: Well, we focus on the profitability of our customers because it is all about trying to create technology that helps our customers to run a more profitable operation than other folks do. We focus on the number of new accounts, the amount of assets that each account has and the margin loans. That's about it.

BRENDAN MATHEWS: You mentioned you are a broker-dealer, in fact, but you're also very much a technology company. Could you talk a little bit about that distinction and how you think about technology?

THOMAS PETERFFY: When I entered into this business some forty years ago, I was a computer programmer and ever since that time I have remained a computer programmer and surrounded myself with other computer programmers. So, unlike other businesses, we do not, as much, focus on sales ... which may be a problem ... but we focus on building technology. Our forte is to automate everything and everybody we can automate. That gives us the opportunity to service our customers at a much, much lower cost than our competitors do and for that reason we can charge very low commissions that for this past month was $4.10 on the average trade and we still have a 50% profit margin. So, it's magic. The magic is called automation.

BRENDAN MATHEWS: How do you manage to stay ahead of other brokers that might also be trying to automate and leverage technology?

THOMAS PETERFFY: They cannot do it the way we can do it because, as I said, we're computer programmers. They are businessmen.

BRENDAN MATHEWS: Before you opened a brokerage, you had a market making business ...

THOMAS PETERFFY: That's correct ...

BRENDAN MATHEWS: Timber Hill. What are the synergies between that business and your brokerage business?

THOMAS PETERFFY: Well, Timber Hill, as you said, is a market maker mostly in options on many of the world's major exchanges. As such, it is extremely important for Timber Hill to be intimately familiar with the technology of each of those exchanges so that we can achieve best executions of those exchanges. We can share that technology with the brokerage arm, so that our customers have the same technology available to them as what we built for Timber Hill.

BRENDAN MATHEWS: You mentioned you're a computer programmer by trade. You've surrounded yourself with computer programmers. That's a key for how you're able to automate and stay ahead. How do you think about keeping your employees happy and retaining your most talented employees?

THOMAS PETERFFY: Well, we hope to give them challenging jobs, which means that we keep them interested by allowing them to come up with their own suggestions and to create systems that are better than on par with elsewhere. So, we don't worry about what other people do. We try to harness our own imagination and go from there.

BRENDAN MATHEWS: It sounds like you're giving people the opportunity to really work on the cutting edge of technology.

THOMAS PETERFFY: Applications, yes. That's correct.

BRENDAN MATHEWS: One of the things that we at Stock Advisor consider very important is leadership, and one of the reasons we have always been excited about Interactive Brokers was your involvement as CEO. But we're also very long-term investors. How do you think about succession for the business?

THOMAS PETERFFY: Well, as I said, I have a number of computer programmers here that have been with us for 20 or 30 years. They are intimately familiar with our systems and several of them would be capable of running the firm — nowadays probably better than I do — given that I'm getting on.

BRENDAN MATHEWS: You've talked about this a lot in the media — is high-frequency trading. It's something that intimidates a lot of investors that are thinking about investing in stocks, for instance. But you have sort of a different take on that. Could you just talk about your opinion on high-frequency trading and how individual investors should think about it?

THOMAS PETERFFY: I do not think that individual investors really should be bothered by high-frequency traders. See, high-frequency traders, on the one hand, most of the time create liquidity that benefits the individual customer. On the other hand, maybe high-frequency traders cause some slippage in executions for customers. So, the important thing is that you choose a broker that has technology that can compete with the technology of high-frequency traders.

But most of all, do not choose a broker who sells your order through, because many brokers do that. So, you open an account with say ... I don't want to name names here ... but every broker has to file with the SEC a quarterly 606 report that you can just look up on Google search, put in your broker's name and 606 report, and then you can see who is really executing your orders that you sent to your broker. It very rarely happens that the broker is actually the one that executes it.

BRENDAN MATHEWS: That's interesting. Now, what about volatility? How does volatility affect your business? Does it benefit your business?

THOMAS PETERFFY: Volatility is beneficial for our business because it makes people more interested ...

BRENDAN MATHEWS: In trading?

THOMAS PETERFFY:... in trading. It gives opportunity for people, especially for options traders, who are nimble in the marketplace, to take advantage of large swings in the market.

BRENDAN MATHEWS: So, you'd expect to be more profitable in a more volatile environment. And what about in a higher interest rate environment?

THOMAS PETERFFY: Well, generally brokers make more money in high interest rate environments. We would do so to a much lesser extent because we pass on the interest to our customers, so it doesn't make a great deal of difference for us.

BRENDAN MATHEWS: Okay ...

THOMAS PETERFFY: But most other brokers make a great deal more money in a high interest rate environment than otherwise.

BRENDAN MATHEWS: When you initially became public, there was a plan to sell more and more shares of the company to the public over time. Is that something you're still considering or thinking about?

THOMAS PETERFFY: We give annual bonuses to all of our employees, and roughly half of those bonuses are in shares that then are blocked for a period of seven years. So, in the course of seven years, they can gradually sell those shares. And as a result, when we went public in 2007, we basically floated 10% of the company and due to these bonus shares, currently 13.5% of the company is in public hands.

BRENDAN MATHEWS: You also mentioned that you cater to more sophisticated investors. Have you ever thought about simplifying your platform a little bit and trying to sell to less sophisticated investors to open up a larger market or is that not something ...

THOMAS PETERFFY: I think that in life, you have to focus on a few things and do them very well. And what we decided to focus on are sophisticated investors. You cannot be all things to all people. So, the answer's no.

BRENDAN MATHEWS: You're focused. That's great. That really concludes my questions. I'd really like to thank you for this interview. Is there anything that I forgot to ask that you'd like to communicate to long-term shareholders of your company?

THOMAS PETERFFY: All that they should care about is that I'm also a long-term shareholder.

BRENDAN MATHEWS: Yes. We know that. We like that. Great. Thank you very much, Thomas.

THOMAS PETERFFY: Thank you.

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