High inflation and rapidly rising interest rates are challenging markets and causing ripple effects across asset prices.
While higher rates end up hurting many stocks, financial sector stocks can also benefit greatly. Banks can earn more interest on loans they make, and brokers can earn more interest on margin loans they offer traders.
Higher rates were a crucial element fueling Interactive Brokers' (IBKR -1.01%) excellent third-quarter earnings results. The broker also built up its key customer bases, boosting its commissions. Even better, there are indicators that Interactive Brokers can continue to perform, making it a top stock to buy in October. Let's take a closer look at the reasons why.
More investors are turning to Interactive Brokers
Interactive Brokers provides electronic brokerage services to tech-savvy investors. It offers a platform to trade stocks, options, futures, bonds, exchange-traded funds, and other financial products. It makes money in two ways: Through commissions from customers for executing and clearing their trades, and net interest income on margin loans it extends to customers.
The broker does an excellent job of automating its platform to be the low-cost provider of choice for various investors. Investors turn to the broker because it offers better execution prices, which can amount to significant sums for some of its biggest clients.
It also builds its platform to accommodate its most demanding investors, automating the most significant parts of that platform and making it readily available for all its clients. Hedge funds recently became a big part of its customer base, so the broker is building out its services to fit their needs. In reality, it's the retail customers and other clients that ultimately benefit from these improved tools.
The customer base generates higher commissions and is growing rapidly
Hedge funds make up a significant portion of Interactive Brokers' commission income. Over the last three years, the number of hedge funds on its platform increased faster than any other leading banker brokers. The broker is currently the sixth largest provider of prime brokerage services and expects to jump to fourth this year -- trailing only Morgan Stanley, Goldman Sachs, and JPMorgan Chase.
Acquiring hedge fund customers is a crucial component of Interactive Brokers' growth. That's because the average hedge fund generates 67 times the revenue of the average retail trader. Proprietary trading groups also turn to the broker for their trading and generate 10 times the revenue of the average retail trader.
Despite lower trading volumes in the third quarter, Interactive Brokers saw its commission revenue increase by 3% compared to the same quarter last year, as the total size of the trades it cleared was larger.
Image source: Getty Images.
Interactive Brokers grew customers and earnings in Q3
Interactive Brokers saw stellar growth across all customers in the third quarter, with total customer accounts increasing 31% from last year. Individual retail accounts grew the fastest at 38%, while proprietary traders and hedge funds grew 28% and 13%, respectively.
One negative was its customers' declining equity balance, which was down 19% compared to last year. This is due to market conditions that punished most asset classes, causing total assets to decline. When market conditions improve, and asset prices recover, Interactive Brokers will see its customer balances grow too, which could encourage more trading and higher fees.
It also benefited from higher interest rates, which allowed it to collect more interest on its margin loans. In the third quarter, net interest income grew 73% from last year and was the primary driver of Interactive Brokers' growth. Taken together, Interactive Brokers saw its total quarterly revenue grow 70% from last year, while net income increased by 134%.
A great company to buy at a good valuation
IBKR PE Ratio data by YCharts
Interactive Brokers currently trades at a price-to-earnings (P/E) ratio of 24.5 -- below its 10-year average ratio of 36. Its one-year forward P/E ratio is just 15.8.
It has done a great job this year despite volatility in the market. The stock is only 8% off its 52-week high at a time when many companies see their stocks down significantly more.
The broker benefited from volatility in the market and its growing hedge fund client base. It also grew its other client bases and is in an excellent position to succeed when market conditions improve. When that happens, retail customers will likely get more involved in the market once again, and its hedge fund and proprietary trading clients will likely continue to trade in high volume.
Given its strong growth and excellent performance in this bear market, Interactive Brokers is a stellar stock to add to your portfolio today.
