Investing in stocks is a great way to build wealth in the long run. But often, the best way to profit from a money-making opportunity is to provide customers with the tools they need, and in the discount brokerage arena, Interactive Brokers (NASDAQ:IBKR) has long sought to revolutionize the way that investors trade stocks and other types of investments by offering low transaction costs. Even as the stock market has soared, though, low levels of volatility have held back trading volumes, and that in turn has held back Interactive Brokers and its broker peers. Unfortunately, the broker wasn't able to turn the tide in its third-quarter results this afternoon, even though more turbulent times in October could finally lead to a change in the industry's fundamental strength. Let's look at how Interactive Brokers did last quarter.
Tough results for Interactive Brokers
Interactive Brokers' third-quarter report included huge declines from year-ago levels, with the strength of the U.S. dollar playing a key role in hurting the broker's results. Net revenue plunged by nearly half to $171 million, with pre-tax income falling almost 80% to just $40 million. As a result, Interactive Brokers reported an overall loss of $0.13 per diluted share for the quarter, reversing a year-ago profit. Yet when you take out the impact that the change in the dollar's value against foreign currencies had on Interactive Brokers' foreign subsidiaries, adjusted earnings came to a profit of a nickel per share. Nevertheless, that still represents a drop of about 85% from 2013's third quarter.
Looking more deeply, Interactive Brokers told a tale of two separate segments. The company's electronic brokerage business actually looked reasonably strong, with several key metrics showing favorable growth. For instance, pre-tax income jumped more than 40% from year-ago levels, as profit margins jumped by about seven percentage points. Interactive Brokers enjoyed higher commission and execution-fee income, which grew about 10%, and net interest income soared by two-thirds as customers took advantage of the broker's below-average margin rates to make leveraged bets on their investments, with margin balances climbing by more than 35%. Daily average revenue trade figures rose 13% to 14%, and gains in both the number of customer accounts and the size of the average account per customer caused Interactive Brokers to see its total equity climb to $54.9 billion.
Where the weakness was, though, was in Interactive Brokers' market-making segment. Even adjusting for currency losses, pre-tax income for segment fell by half, and $133 million in losses tied directly to adverse movements in the U.S. dollar against foreign currencies led to a $112 million pre-tax loss for the division.
Moreover, Interactive Brokers' strategy toward diversifying itself against foreign currency fluctuations backfired during the quarter. The company's strategy involves holding a basket of 16 major currencies, but their aggregate value dropped by about 4% against the dollar. That cost Interactive Brokers about $211 million in potential earnings for the quarter, with those portions not attributed to the market-making segment covered in the company's catch-all other-comprehensive-income category.
Will turbulent markets help Interactive Brokers?
For a company that targets high-trade-volume customers, the relatively boring markets of the past few years have made it tough for Interactive Brokers to take full advantage of its long-term profit opportunities. In the release, Interactive Brokers blamed "the ongoing difficult competitive environment, lower average volatility, higher global M&A activity, and a trading error that resulted in a loss of approximately $16 million" for the reversal in its market-making profits.
Interactive Brokers isn't alone in feeling the effects of the current market environment. But by offering low margin rates and cheap commissions, Interactive Brokers is an especially popular choice among those who use higher-volume trading strategies, and when those strategies are ineffective, it can hurt Interactive Brokers' overall success.
In that light, though, the turbulence that markets have seen in October could well jump-start Interactive Brokers' growth. If traders start to see new chances to profit from big market moves, then their activity should show up in Interactive Brokers' trading figures.
Despite the company's disappointing results this quarter, Interactive Brokers shareholders need to understand how volatile its results can be. If the dollar's recent strength reverses and greater trading activity from the market's recent hiccup lasts for a while, then Interactive Brokers' future could look a lot brighter in the months and years to come.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Interactive Brokers. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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