“Immigrants… they get the job done” – Hamilton Muscial. Interactive Brokers (Ticker: IBKR)

Given my background, I have always had a soft spot for a good immigrant success story.  Thomas Peterffy immigrated from Hungary at the age of 21 and he was introduced to Wall Street by being in the right place at the right time.  After he acclimated, according to Wall Street folklore, he was one of the first people (if not the first) to begin using computers to make markets on the floor of an options exchange. His company at that time was Timberhill, and at its peak, it was one of the largest options market makers.  In 1993, Thomas started a brokerage business, Interactive Brokers (IB), with the idea that he would automate all the processes, resulting in lower operating expenses. 

Below is a comparison of the profit margins of various retail brokers:

As amazing as it sounds, 71% pre-tax profit margin is not a typo! It is a testament that when you build technology right, it scales.

In my opinion, IB is one of the most efficient operations in retail brokerage, which allows it to offer very aggressive rates to its clients, rates that other brokers would have difficulty competing with. 

Below are some of the features and rates that IBKR offers:

● The interest rate on cash in the US is 4.83% (Treasuries – 50 bps) – that’s more than most banks!

● Interest rate on margin loans in the US: 6.83% below $100K, 6.33% above $100K, and going down (Treasuries + 100bps) – I don’t know of any other broker charging such a low rate.

● Portfolio Margining – allows clients to have a significantly larger margin position than under typical rules.

● T+1 Settlement – relevant for people trading options. If your stock gets called when the option is exercised, IB allows you to replace that stock and avoid paying gains.

Thomas still owns 75% of the shares, currently worth over $30Bn.  It is also my understanding, that Thomas who is now 79, would come to work every day well into his 70s, and very possibly may still keep going today!

Below are annualized returns for the Interactive Brokers covered calls that expire on January 17^th, 2025

Note: Premium and returns are calculated by a Covered Call calculator created by the Options Clearing Actual premium and returns will change depending on the stock price and execution.

Company Overview

At its core, Interactive Brokers is doing the same thing as Schwab, ETrade, Robinhood, Merrill Edge, and other online brokers do.  This is a place where you go to open a brokerage account and execute trades.  The difference between IB and other brokers is that it feels like a platform developed for active traders adopted for pedestrian use.  Of course, there is also a cost difference on certain items, which helps. 

At a high level, IB has two sources of revenue:

1. Commissions – the money it charges clients to trade on its platform.

2. Interest Income – it makes a spread on such things as the cash you hold in the account, margin loans, lending stock, etc.

As clear from the table above, Interest Income is a much bigger driver of revenue and I suspect has gross margins close to 100%.  For the spread business, it is less important whether the rates go up or down, and more important that they stay high enough from the floor so that the broker can capture a spread.

Business drivers are very straightforward; get more clients and the rest will come.  IB was able to grow client accounts by over 30% per year for the last seven years, which in turn resulted in clients increasing money in their IB accounts (client equity) and using that money to trade (commission revenue), trade on margin (margin balances), or sometimes just leave some cash sitting in the account (client credit). 

Below are selected valuation metrics on IB

For 2024 I just assumed a historical average growth of 20% - feel free to make your own assumptions.  I am sure we will be both wrong.

Risks

There are obvious risks - the growth may slow down, Thomas Peterffy is no longer a spring chicken, etc.  However, the Financial Services industry is probably one of the few industries where you can go to bed happy and wealthy and wake up broke and humbled.  Graveyards are full of people and companies who forget that the financial services business starts and ends with risk management.  Great businesses have disappeared very quickly, sometimes in days because of lapses in risk management. If I own a financial services stock, I keep my eye on the news for any signs of lapses in risk management, and if I see any, I run. 

My positions

When I started writing this article, IB was in the mid-90s, and since then it has run up to about $105.

Last week, when the stock was at $106, I wrote a covered call with the strike price of $90 expiring on Jan 19, 2025, with a return of up to 11%.  However, I was a bit torn on whether I should wait to see if stock will dip a bit, but I guess it is an individual decision.

Musings

“After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I've known many men who were right at exactly the right time and began buying or selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine that is, they made no real money out of it. Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money. It is literally true that millions come easier to a trader after he knows how to trade than hundreds did in the days of his ignorance.”
― Edwin Lefèvre, Reminiscences of a Stock Operator

This is one of my favorite quotes because it is so true.  If I think about my investing mistakes, not being able to sit tight has probably been my costliest.   I owned a lot of Apple shares more than ten years ago and didn’t hold on. I bought MSFT at $30 and sold it at $38, with its current price being $404. That one will always sting.

I spent my formative years in Merrill Lynch in the early 2000s’ and knew the story of Interactive Brokers very well, and yet I just watched from the sidelines, looking for the right moment, as the stock went up, but not pulling the trigger.  Shares went from $35 to $105 in 8 years – 14% annualized return.  I finally bought shares in December of 2023 at $78 per share.  Now the big question is if I will just be able to sit tight.

I’ll end this letter with a quote from the Founder’s Letter on the IB website:

“Investment by passive investors, and by others who do not use our platform, tends to cause a run-up in our share price. This makes it more difficult for our clients to purchase our shares. You may be considering investing in IBKR. We would like to ask you not to buy our shares unless you become an active user of our platform prior to doing so.

Sincerely yours,

Thomas Peterffy”

Happy Investing,

Sam

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Behind the Curtain: The Story Behind Endgame Mindset Newsletter

After graduating from NYU’s Stern, I started my adult life as an Investment Banker in Lehman Brothers’ Mergers and Acquisitions group. I have spent the majority of my professional career as an investor, investing on behalf of large institutions such as Morgan Stanley, Merrill Lynch, and Bank of America, as well as a private equity fund and helping companies buy other companies.  In my free time, I spend a lot of hours researching stocks.  A lot. It is hard to save your way to retirement without making good investments. 

Recently, I have also started focusing on Covered Calls.  My goal with covered calls in the current rate environment is to generate a 10-12% unlevered return.  In writing this newsletter, I share my analysis and what I own with others, hopefully helping them earn steady and attractive returns as well.

Disclaimer:

Although the information contained in the newsletter is obtained from sources I believe to be reliable, I cannot guarantee its accuracy. Calculations made in this letter are based on my estimates and not only do I make mistakes but actual performance will almost certainly be different from my projections. The opinions expressed in the newsletter are mine and may change without notice. The information in the newsletter may become outdated and I have no obligation to update it. The information in the newsletter is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. It is provided for information purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell, or hold a security. No recommendation or advice is being given as to whether any investment is suitable for a particular investor or a group of investors. It should not be assumed that any investments in securities, companies, sectors, or markets identified and described were or will be profitable. I strongly advise you to discuss your investment options with your financial adviser before making any investments, including whether any investment is suitable for your specific needs.

Do your homework before putting money at risk!