The market seems focused on artificial intelligence (AI) stocks right now, but they might be overlooking some very attractive opportunities in other areas of the stock market. Interactive Brokers (IBKR +1.22%) is the world's largest provider of online brokerage services, dealing in stocks, futures contracts, options, and more.
Interactive is benefiting from the bull market in stocks. It currently serves a record number of clients, and the value of the assets they hold on its platform is also at an all-time high.
Interactive stock is up a whopping 80% this year, more than three times better than the 23% return generated by the S&P 500 (^GSPC +0.66%) index. Despite its strong gains, the stock's valuation remains cheap, which sets it up for another potential surge in 2025.
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Client equity soared during Q3
Bull markets tend to bring new investors into the fold. Nobody likes to miss out on making money, especially when they constantly hear the media -- and even their friends -- talking about the market's strength. At the end of the third quarter of 2024, Interactive had a record 3.1 million customer accounts, which was a 31% jump from the year-ago period. The company said it was the strongest quarter since the meme stock frenzy in first-quarter 2021.
Those customers were holding $541 billion in cash and financial assets in their Interactive accounts at the end of the quarter, which was up a whopping 46% year over year. Client equity tends to rise in lockstep with the broader market, because the value of each clients' holdings increases organically. However, the S&P 500 is up just 33% over the past year, suggesting Interactive's total client equity is benefiting from lots of new deposits.
Interactive's clients also had $55.8 billion in outstanding margin loans at the end of Q3, which was up 28% year over year. That's a clear sign of bullish sentiment because investors typically borrow money to buy stocks and other financial assets when they have a high degree of confidence that the market will head higher.
Trading activity was also up significantly during Q3. Interactive's options, stock, and futures volume grew 35%, 22%, and 13%, respectively, compared to the year-ago period. High volume in risky financial derivatives like options can be a sign of growing risk appetite among investors, and that typically happens when markets are strong.
Commission revenue surged in Q3, but lower interest rates could be a headwind
Interactive has two primary sources of revenue. First, it earns commission revenue for processing client transactions, which is the company's core business. Second, it earns interest revenue from its margin loan book, and from the cash it stores in bank accounts (its own cash, plus the cash it holds on behalf of clients).
Interactive generated $1.36 billion in total revenue during Q3 from all sources, which was a 19% increase from the year-ago period. Thanks to the strong trading volume it processed across the board, the company's commission revenue surged 31% to $435 million.
Net interest revenue came in at $802 million, which was an increase of just 9%. This part of Interactive's business could slow in the coming quarters now that the Federal Reserve is cutting interest rates. The central bank slashed 50 basis points off its benchmark rate in September, and forecasts suggest it could cut another 50 basis points before 2024 is over, followed by a further 125 basis points in 2025.
That's going to be a significant headwind for Interactive's interest revenue. With that said, the company had $35.2 billion in segregated cash (client money) on its balance sheet in Q3, which was a substantial jump from $26.3 billion in the year-ago quarter. Combine that with the increase in margin loans referenced earlier, and those higher balances should offset some of the decline in interest rates (Interactive will earn a lower rate of interest, but it will be on much larger sums of money).
NASDAQ: IBKR
Key Data Points
Interactive stock is still cheap, despite its solid gains
Interactive stock is currently trading near a record high following its 73% gain this year, but it's still relatively cheap. Based on the company's trailing 12-month earnings per share of $6.56 and its stock price of $146.78 as of this writing, it trades at a price-to-earnings (P/E) ratio of 22.3.
That's a 10% discount to the S&P 500 index, which trades at a P/E of 24.7.
Falling interest rates will be a headwind for Interactive's top and bottom lines going forward, and it appears to be baked into Wall Street's forecast already. Analysts predict the company will generate $6.84 in total earnings per share in 2025, which would represent no growth compared to the analysts' expected 2024 result.
From that perspective, I understand why investors don't want to pay a premium for Interactive stock. On the other hand, falling rates typically support stock prices, which could drive a wave of new customers to Interactive Brokers next year, and boost its client equity even further. That means the company is likely to generate record commission revenue in 2025, which could offset some of the shortfall in interest income.
Therefore, Interactive stock has a real chance to build on its 73% gain so far in 2024. That makes it an attractive opportunity for investors, especially at its present valuation.
