Interactive Brokers Q3 Earnings: Top Takeaways for Investors

Trading platform Interactive Brokers (IBKR 1.39%) reported its third-quarter earnings results on Oct. 19. With so many online trading platforms to choose from, what differentiates Interactive Brokers from the rest? In this segment of Backstage Pass, recorded on Oct. 19, Fool contributor Billy Duberstein dives into the company's earnings report and core business model. Fool contributor Brian Withers is also in the clip.

Brian Withers: Billy, Interactive Brokers announced little after four o'clock today, so what's going on with them?

Billy Duberstein: Let me bring out my screen here. Interactive Brokers, I don't know if anybody uses Interactive Brokers. They are my broker in particular, so I'm a big fan of their products, it looks like a solid quarter at first glance. The press release just came out about 20 minutes ago, and let me see, revenue up over 25% which beat expectations. Adjusted earnings per share, $0.78 beat $0.75, expected. The company doesn't give outlook typically.

We just have this quarter to go on. For those not familiar with Interactive Brokers, these guys are perhaps the most technologically forward of the major discount brokerages. They typically have or had the lowest cost in the industry before the zero commission revolution, if you can call it zero commission pioneered by Robinhood. For those following that story, when a company offers you zero commission, sometimes they get paid to sell your order flow to high-frequency traders.

Interactive Brokers is a pretty good job of adapting. They actually give customers the option of whether they want better execution for their typical low commissions or I think since about a year ago when all of this happened, the price was taking commission rates to zero, they started giving an option called IBKR Lite, which allows you to trade for zero commissions with the knowledge that they're going to trade your order flow to high-frequency traders.

Anyway, as you can see the stock has had a quite a good year in 2021. I think the stock price is still below where it was about a few years ago though. I think that's because the advent of Robinhood coming into the market. There's a lot of fears about commission compression.

That took the multiples down for all of these older discount brokerages. But as you can see from the results, these guys just keep on growing commissions. Basically they make money in two main ways, commissions, revenues, which is commissions for trading, options trading, and then net interest income on their margin loans. They also will lend securities to short sellers and get paid interest on that.

If you're a client, I believe you can choose to split the interest with Interactive Brokers. You can basically say, yes, I give permission to lend my securities to short-sellers, and you get paid that way. Those are the two main ways they make money. They also have some other income, which was very messy this quarter, which I'll get into in the second. They've got some investments and they have to value of those investments. They also earn interest on their cash balances.

They put it into treasuries. This is an international company. They're all over the world. They actually put their cash holdings in ten different currencies. Based on how those currencies move in any quarter, they record gains and losses from that. Those gains and losses, there's actually a sizable loss this quarter, but that other income can bounce around a lot, so it's not really core to the business. This revenue and earnings per share is adjusted really based on the commissions and the margin loans.

Before I get to the wrinkles in the other income, I just want to get to some of the core metrics that the company also gives along with just revenue and earnings-per-share. Commissions revenue up 11%, interest income 41 percent. Customer accounts. This is what I look to. It says, in any given quarter commissions can go up a lot, they can go down a lot based on market volatility.

Net interest income can bounce around based on interest rates and the spread. But as you're growing, customer accounts at 57%, that's pretty good. The revenue and earnings can bounce around a little bit, but if customer accounts keep growing, that's what you want to see. So 57% total customer equity up. I think that's a typo. I think it was up 52%. Equity is up a little bit less than customer accounts. DARTs. That's daily average revenue trades was up 24%.

That means on average, customers were trading less frequently than they were a year ago because that was only half the growth of customer account growth. Total margin loans up 67%. I think this year people are taking a little bit more risks in their equity portfolios than they did in 2020 during the pandemic.

Interactive Brokers is benefiting from margin loan growth. You can see that net interest margins increased a little bit last year when basically interest rates were at zero or pretty close to it. They're still very low, but increase a little bit. One wrinkle, the other income took a big hit. Their GAAP revenue and P/S is going to be lower than that adjusted figure. These guys actually have, I believe, a 7.5% stake in a another public company called UP Fintech Holding. This is a brokerage in China.

As we all know, it was not a very good summer for Chinese related stocks. That stock is actually down by more than half since June. Interactive Brokers actually took a $185 million mark-to-market loss, which shows up in their GAAP results, but really doesn't have anything to do with the core business, it just had to do with the stock price of a company that they are invested in.

I wouldn't reach too much into that. But all in all, just another solid quarter, 57% account growth is really solid. They beat on revenue and earnings per share. Just not too much that's newsworthy, just a solid earning speed.