Value Investors Tribe

Analysis Date: January, 2024

For the analysis of any business, I use the framework described by Warren Buffett in 2007 letter to shareholders. Warren Buffett looks for four parameters particularly: a) Understandable business economics b) Long-term growth prospects c) Able and trustworthy management d) A sensible price tag.

Business Economics and its Moat

Interactive Broker provides broking services and that’s its primary operation. Primary competitive advantage is it operates with lowest trading cost compared to its competitors. The closest competitor charges about 30%-40% higher trading cost than Interactive Broker. It has a deep moated technology which small guns cannot compete against and hence the Interactive Broker has a pool of potential acquisitions and customers to acquire. Additionally, with the advent of ML and AI, the powerful will get more powerful since they can leverage the technologies quicker. This will not be a significant factor however it can play out reasonably well with development in technology. Biggest moat of the company is providing the trading across the major global markets in most of the major global currencies. Additionally, the company practices delayed gratification like COSTCO and Amazon and few other companies; it operates with about 1% or 2% net interest margin and hence increasing the longevity by making the product attractive to customers. It provides highly competitive rates on uninvested cash barring about 50 to 100 bps compared to the fed fund rate. This provides a lucrative platform for smart investors to keep their uninvested cash in the account.

Growth Prospects

It has been growing its accounts at about 18%-20% historically for the last 15+ years and has about 2.1 million accounts. Historically averaging, it adds about 1 country and 1 currency per year which is a significant amount of time to ensure the regulation and legal formalities are completed. The company provides great investment and trading tools which covers a wide spectrum of beginner investors to hedge fund investors. This leads to high retention rate and additionally the low costs boost the popularity. With the awareness of investment and despite not being a personal believer, people love diversifying so global diversification is bound to get more traction with time. Similar is the case with options, derivatives, margin lending and similar other products the company offers.

Management Trustworthiness

Interactive Broker was founded by an immigrant and majority of the company is privately held. Most of the senior leadership has been with the company for 20, 25, 30 and even 35 years. The management has been candid with the shareholders and has been forefront in admitting mistakes. They have the skill sets necessary to move in the right direction and potentially faster than their peers. The capital allocation has been rational and the return on reinvested capital has been moderate. Company has a long run way for reinvestment.

Valuation

The accounts have historically grown at 18%-19% on a CAGR basis however as the company grows in size, this type of grown is not sustainable. As a result, for the DCF calculations, a moderate 10% growth rate is assumed and a terminal growth rate of 3% is assumed after 10 years. The business has considerable exposure to global market conditions and so even though the risk free rate is about 5%, the discount rate of 8% is used for calculations. Detailed DCF calculations are shown in the table below.

• Sum of Present Value of FCF (million $): 7601.6
• Terminal Value (billion $): 33564.4
• Present Value of Terminal Value (billion $): 15546.8
• Total Equity (billion $): 23148.4
• Shares Outstanding (millions): 107.2                                                                                                                          
• Intrinsic Value (per share): $216
• Current Trading Price: $90
• Margin of Safety: 58%

What does this mean? This implies that based on our DCF assumptions, Interactive Brokers is currently undervalued with its intrinsic price somewhere around $200.

Disclaimer: This fundamental analysis of Interactive Brokers is primarily for educational purposes so as to help value investors learn core concepts. This is not a buy or sell recommendation of any form whatsoever. Reader discretion is advised.