The stock market is in a rut at the moment. While the benchmark S&P 500 index is still comfortably in the green for 2023, it has fallen 7.6% since the beginning of August.
One of the headline issues weighing on the market right now is the after-effects of a rapid rise in interest rates. The average 30-year fixed mortgage rate moved above 8% last week, and U.S. government Treasury bonds now offer investors an attractive risk-free annual return above 5% in some cases, which is keeping them out of the stock market.
Still, there are some companies benefiting from the increased volatility and higher interest rates right now. Interactive Brokers (IBKR -1.17%) is one of them. Here's why buying this stock can help investors weather the recent market sell-off.
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Heightened activity from investors is a tailwind for Interactive Brokers
Interactive Brokers is one of the largest online investing platforms in the world, and it's popular with retail investors, professional investors, and hedge funds alike. Stock market volatility is caused by heightened trading activity among those investors, and since Interactive earns commissions each time one of its clients buys or sells a stock, options contract, or futures contract, these moments are great for business.
The company just reported its financial results for the third quarter of 2023 (ended Sept. 30). While share trading volume was down 22% year over year, Interactive saw an 18% jump in options trading volume, where it earns much higher commissions. Options activity tends to rise in periods of high volatility as investors hedge their downside risk and also try to profit from unusual moves in the market.
Drops in the stock market are also often plastered in the news headlines, so volatility tends to attract new investors. Interactive had 2.4 million customer accounts at the end of Q3, which was an impressive 21% increase compared to the same time last year.
Customer equity -- which is the total value of all cash and assets held by Interactive's customers on its platform -- also jumped 29% to $369.8 billion, thanks mainly to higher asset prices compared to last year, when the stock market suffered an even steeper decline. This is an important metric because of Interactive's commission-based fee structure; the higher the value of client assets, the higher Interactive's fee-earning potential.
Interactive Brokers' revenue is soaring thanks to higher interest rates
Despite all of the aforementioned tailwinds for Interactive's core business, its Q3 commission revenue only increased by 4% year over year. The real standout for the company was its interest revenue.
Interactive earns interest income on the cash its clients hold on its platform, which the company stores with its bank partners. Plus it earns interest income when it writes margin loans to clients to buy stocks and other financial assets.
The rapid rise in interest rates over the last 18 months means Interactive earned a 4.97% return on cash deposits in Q3, which was three times higher than the 1.63% it earned a year ago. That resulted in $1.6 billion in interest income, more than double the amount it generated in Q3 last year.
Plus it gave Interactive a 2.46% net interest margin (the difference between the interest it earns and the interest it pays out to clients and lenders), which was substantially higher than its 1.67% net interest margin a year ago.
It resulted in $744 million in net interest income, which drove Interactive's earnings per share (profit) 60% higher to $1.56 for the quarter.
Why Interactive Brokers stock is a buy now
Interactive Brokers has generated $5.50 in earnings per share over the last four quarters, and based on its current stock price of $80.15 it trades at a price-to-earnings (P/E) ratio of just 14.5. That's the cheapest level in over 10 years, and it's also a 51% discount to the broader tech sector, represented by the 29.9 P/E of the Nasdaq-100 index.
That implies to me that investors don't expect higher interest rates to stick around for much longer, which means Interactive would lose its biggest windfall. But according to the CME Group's FedWatch tool, the U.S. Federal Reserve isn't expected to start cutting interest rates until June 2024. Plus, it could take more than a year from that point to unwind all of the recent interest rate increases -- assuming the Fed wanted to, which seems unlikely.
In any case, falling interest rates would likely make stocks and other financial assets more attractive to investors once again, which could drive an uptick in commission revenue for Interactive.
Therefore, not only is Interactive Brokers stock a great buy in the short term because it benefits from many of the factors driving the market lower, but it could also be a solid investment for the longer term.
