There was a time when you would have to pay commissions every time you bought or sold a stock -- with these fees costing you anywhere from $8 to $10 per transaction. This all changed in recent years.
Robinhood was one of the first to offer commission-free trading, and in 2019 several online brokerages -- like Charles Schwab, E*Trade, and TD Ameritrade -- followed suit. Commission-free trading was possible because brokers began routing trades through companies known as market makers, which handle orders and take a few pennies on every order they handle.
The practice has been the subject of scrutiny from regulators, who threatened to ban it altogether. This would have crushed market makers like Virtu Financial (VIRT 2.56%). However, with the Securities and Exchange Commission (SEC) announcing it wouldn't ban the practice, is Virtu Financial a buy?
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Companies like Virtu have ushered in commission-free trading
Virtu Financial operates as a market maker, an essential part of financial markets. When you want to buy or sell a stock quickly, market makers stand ready to take your order at a moment's notice. Without market makers, you would have to wait for your buy order to match up with a sell order. Market makers can reduce volatility in the market and encourage more trading volume, facilitating price discovery and improving the market's efficiency.
Virtu makes money by offering two quotes: the price it's willing to buy a security (bid) and the price it is willing to sell the security (ask). The difference between these prices is called the bid-ask spread and is usually just a few cents. When market makers transact millions of shares daily, these pennies can add up to some serious cash.
Investing brokers like Robinhood or Charles Schwab send their flow of buy and sell orders to market makers so they can facilitate trades on their platforms. Market makers then return a portion of their earnings to the brokers, known as payment for order flow. These brokers argue that payment for order flow is the reason they can offer commission-free trades and make investing more accessible to all people.
Regulators have scrutinized payment for order flow
Companies like Virtu have come under scrutiny in the last couple of years, with regulators focusing on payment for order flow. Last year, SEC Chair Gary Gensler said he was considering a ban on the practice. Gensler argued that it creates a conflict of interest for brokers who may be more focused on maximizing profits instead of delivering the best prices to their customers.
The SEC recently said a ban would not happen, but it would consider other actions that could change the way orders are routed and require brokers to inform customers about how much it costs to trade with them compared with benchmarks. Experts say that these rules could potentially make payment for order flow less profitable.
Virtu trades at a cheap valuation
Virtu investors breathed a sign of relief that the SEC didn't ban payment for order flow. While its earnings may come under pressure from additional rules around the practice, it is already trading at a very cheap valuation.
Since April, Virtu's stock has fallen over 42%, and it now has a price-to-earnings ratio (P/E) of just 6.8. Its price-to-sales ratio of 0.96 is also below its historical average since going public in 2015.
Data by YCharts.
Options and cryptocurrency will power Virtu's next growth phase
Virtu benefits from volatile markets. That's because volatility can cause the bid-ask spread to widen, increasing the amount the company earns on every trade it facilitates. This was evident in the second quarter, when its revenue grew 10% to $604 million, driven by solid market-making revenue, which increased by 7.5%.
The company is forging on with its market-making business and is expanding into options and cryptocurrency markets next. Virtu is improving its models for options market making and expanding the number of stocks it covers. Douglas Cifu, CEO of Virtu, told investors that the company was seeing triple-digit growth from its options market-making business this year, and it's going "full hog" into the business. It's also seeing stellar growth from its crypto segment, and its adjusted net trading income from this business was a record in the second quarter, even though crypto prices were falling.
A solid dividend stock with a cheap valuation
Virtu has rewarded investors with a dividend that yields 4.36% while buying back another $788 million in shares in the second quarter alone. It still faces uncertainty regarding what the SEC will do about payment for order flow, but with the shares sporting a cheap valuation, it could be an excellent stock to buy on the dip and hold for the long haul.
