B (3:26)

Yeah, to understand the history of interactive brokers, you have to look at the life of Thomas Petterfy. Thomas Petter Fee is, I put here, probably the most successful entrepreneur you've never heard of. If you are unfamiliar with interactive brokers. He An 81 year old Hungarian born founder who is now I believe as of this recording, worth approximately $80 billion and is widely considered the pioneer behind the shift to digital financial markets. And his. You should anyone that's interested in Thomas Peterfy. I'm going to go through a bit of his life, but you should read up on him. It is truly an astounding like entrepreneurship story because I think he's one of the only people who's gone from true. Like at one point I think he was homeless to literally worth $80 billion. But let's go through his life. He was born in socialist Hungary in the middle of World War II. He says he was literally born during a bombing raid and ped. In all the interviews he's done, he often talked about like instantly not liking socialism, like being frustrated with the lack of incentives to work hard. There was not like any benefits to innovating and all this stuff. And he could, he says he could tell early on it wasn't for him and he wanted a way out. I believe his father had left apparently. I think we both read the same interview from Colossus that they did with him. His father was supposed to be like the minister of Finance or something, potentially like a really high up role. And he was a bright guy but ended up fleeing the country anyways. It's besides the point. He remembers being frustrated by socialism and he tells a story. He says one time when he was 12 years old, an American GI gave him a pack of Juicy Fruit gum. And, and this tells you what, what the conditions were like at the time. He cut every piece of Juicy Fruit gum into five separate pieces and started like distributing them for money in the schoolyard, these little tiny pieces of Juicy Fruit gum. And he said he made a decent bit of money to him at the time anyways. And the principal called him in and asked him, where is your communist conscience? Why are you going around selling stuff in the schoolyard anyways? In 1965, at the age of 21, Peter Fee was lucky enough to secure a short term visa to West Germany because he was air quotes here visiting distant relatives. Apparently he had no interest in doing that immediately when he got to West Germany, he went to I think the US Embassy or the immigration center and applied to immigrate. And once he was accepted, he bought a one way ticket to New York City. And he recalls this time as being pretty difficult. He says when he got to New York he had little money, little to no money, so spoke zero English. And he says New York was cold then and it's still cold like, like the people, personality wise are kind of cold is what he was saying. Anyways, when he got there, he was able to get a job as a draftsman for road maps at a highway engineering firm. And he was paid a whopping $65 per week. He apparently he studied advanced geometry in technical school while he was in Hungary. So I guess it sounds like he had some transferable skills for that was where he sort of found a knack for computers. So there was a. And I did not know what this device was, but there was an Olivetti Programa 101, which was a programmable desktop calculator that would sit in the corner of this highway engineering firm and no one would use it. So he says he started using it to like automate calculations that everyone was doing by hand. And by the end of the year, every engineer at the firm, all his colleagues would come up to him and say, hey, can you run these calculations on the calculator? And that was sort of his first, I guess, experience working with technology, seeing the benefits of true, truly automating some tasks. Four years later, I'll skip through a little bit here. Four years later, Peter parlayed his computer knowledge into a job working for. And this was a little bit confusing, but it was a psychiatrist named Dr. Henry Jarecki, who had also built a commodities trading firm on Wall Street. I think he stopped his work as a psychiatrist and started this firm. And apparently this was actually pretty successful. The commodities trading firm was. And he was an early hire for Jarecki. And apparently within a few years the commodities firm had Grown a ton and Peterfleet being an early employee there. His sort of importance grew and this was kind of his taking a step up from earning dirt poor wages and looking for places to stay to having sort of stability. Anyways, after they had gained success in the commodities market, Pederfi was imploring his boss to expand into options, the options market because he thought there were a lot of mispricings and he had actually developed his own sort of price option pricing model that. It's contentious, but some people say Black Scholes was first. Some people say Thomas Petterfi's model predated that. I don't know, but just know that he was thinking on his own. Had built an options pricing model that he thought could derive different values for options and he could get some edge there. So Jarecki refused. He didn't want anything. He was like, we're sticking with commodities options. Is this like risky operation? We don't want anything to do with it. So Pederfi 1977, bought a seat on the American Stock Exchange, not to be confused with the New York stock exchange for $36,000. I think this a good chunk of his, his money at the time. And began trading options on his own. This was sort of the really where you could say the beginning of interactive brokers kind of actually begins. So he would, and at the time there was a. Automation as well, as much automation as you could get. It was basically outlawed at a lot of these exchanges. So he would do calculations on what the, he thought the options were worth based on his pricing model for various companies. And he'd bring them in note sheets on like note cards to the trading floor and have the like the values ready to trade based on whatever was offered at the time. This eventually evolved to him creating, putting a computer on the back wall and he would have, he had his office like next to the exchange. He had a computer on the back wall. He would have traders that would go to and from the computer. You weren't allowed to have like a handheld device yet to and from the computer and check what the latest update was for the option value. And then that was kind of the second evolution, if you will. And then finally he created a, and I find this impressive. He created a handheld computer and there's pictures of this online. If you look up like interactive brokers, early handheld computers that would update the options pricing in real time or the options values. Apparently the exchanges outlawed this because. Or they created a bunch of rules around it, like the computer wasn't allowed to have sharp Corners because it might bump people in the pit, which is funny.

A (11:16)

You've watched Trading Places. It was crowded back in the day. There was actual people down there.

B (11:21)

Did you know Trading Places was loosely based off like, Peter Fee? Like he inspired the movie part of it.

A (11:30)

Really?

B (11:32)

Yeah, yeah, apparently I read that at

A (11:35)

least the culture or something.

B (11:37)

No, no, it was like one of the characters. He inspired the story because he was training these traders and he was basically saying, like, I think anyone can do it. And he was actually hiring. He would hire these young men that wanted to get into finance and he'd have all the updated pricing on these automated handheld computers and no one would deal with them. Like nobody would exchange with them because the. They actually thought it was like unfair that they had this advantage so they wouldn't get any transactions. So he actually hired like young, attractive women is what he said. And all of a sudden his. His volume, his trading volume started soaring.

A (12:15)

A tale as old as time. A tale as old as time. You can say one thing about their entire him and Interactive Brokers and kind of the culture that's led to today is they're crafty to either get around rules or just use the technology or tools at their disposal to try to gain an edge.

B (12:37)

Yeah, he was very much like a pioneer for digital markets. Like a lot of this stuff, like you said, he was either violating rules

A (12:46)

or

B (12:48)

cutting corners potentially on what the rules might be. But yes, trying to get around to basically create whatever edge he could. And eventually this operation, this options purchasing, real time, like lowest latency, basically creating a market maker eventually was so successful that he put a name on it. This was. He named it Timber Hill. And Timber Hill did go on to become one of, I think, pretty much the leading market maker for options. So he had built this very successful operation that was largely built on information latency advantage. He had real time prices, he had quicker updating models, and he was able to trade on that and basically build this small edge that built over hundreds and hundreds of transactions could get him a whole bunch of alpha. And he decided, I guess he says at this time that was sort of early 1990s, they were a leader in the industry. There was starting to be more competition. But he says he was at a crossroads. He was coming to the realization that that same technological moat that were. That was creating this massive profit pool for him, he thought could be turned into a product for the very people he was trading against. Thus, Interactive Brokers was born. And I think that was 1993. So he opened the gates to his Electronic network with the launch of Interactive Brokers. I'll pause there. Any thoughts on the history?

A (14:20)

Well, for anyone that is going to do a correct US$65 a week is not that terrible. I wouldn't call it dirt poor. It's $650 a week in today's dollars. So you know, on the low end, but not somehow.

B (14:35)

That's tough.

A (14:36)

Yeah. I'm just saying he wasn't homeless most likely.

B (14:41)

Well, he says at one point he, at one point after that job he had, I can't remember but in this interview he basically says he had no home at the time he needed a job, had no home, was staying with people and then ultimately obviously 15 years later had built the largest market maker I think on Wall street maybe.

A (15:04)

Yeah. And that is actually another early kind of addition of what has evolved into some of the bigger players. Citadel. What are the other ones? Virtue for two Financial. Some of the ones that they kind of actually seeded the entire business to and focused on Interactive Brokers. But we're going to get into, I mean this is still the 90s. They started with more professional individual traders as well as professional funds. They're trying to find a niche within this market that people want this type of product. But as people are going to see throughout this episode I've gone to today, they actually serve now really essentially from if you want to be a Robinhood type small time trader, they have the products for that. So maybe go through what the product has evolved to now, who they serve and kind of what you thought about their business strategy. And you have it here, Automate everything kind of their technological superiority that allows them to have. Spoiler alert last quarter, 80% profit margins.

B (16:05)

Yeah, I think he actually has written a book or there's a book written about this called Automate. This about sort of the Thomas Petterfi interactive broker story. But this isn't meant to just be purely business history because we're going to talk about why we think it's a good business today. But I think the foundations for how the business was set up actually kind of give a better understanding for why Interactive Brokers is differentiated now. So Interactive Brokers has spent the last three decades call it 23 years. No sorry, 33 years iterating and building digital infrastructure that's designed to serve at least in those early days, specifically sophisticated or advanced traders. Side note, the word Automate shows up 73 times in the Interactive Interactive Brokers Annual Report.

A (16:57)

Good old control F. That's, that's one of the underrated tools for Research, Yes.

B (17:03)

But importantly, as Interactive brokers was building this business out, pederfi was apparently fixated on automation. He knew that they needed to build systems that scaled really well and that's what they've now done for three decades. So, and I know you might say, well, every, every company talks about how they want to automate systems and make it scalable and all this stuff. How's that special? I'm going to go through a few examples of systems that are critical to IBKR that they've done a very good job automating. So the first one is order routing. This gets really more sort of the plumbing behind financial markets, but it's super important because it's a big differentiator for them. IBKR has smart routing, their proprietary smart routing technology. They put like a trademark on it in all their disclosures on the website. And it's unique because it functions as a multi venue dynamic search engine for your trade. So where most brokers send your order to a single market maker and think like Robinhood's a good example of this, they'll send it to a single market maker, they'll have a good deal with that market maker, they'll earn a good spread, a bigger fee because they've got that like exclusive deal that is going to create a bigger pricing gap essentially between the market maker and your quoted price. So ibkr, instead of having just that one agreement, they scan all available markets and dynamically reroute parts of an order if a better price appears elsewhere while the order is still working. So if you've ever placed a trade on IBKR and actually ended up buying shares for lower than your limit price, lower than you were expecting. And I know, Brett, you and I have both had this experience. This is why they've got really sharp smart routing technology. They're not cutting corners and taking bigger spreads just to do it. They are giving you the lowest price possible, which is very helpful, especially for advanced traders, sophisticated traders, investors that are moving big orders.

A (19:13)

Yep. And this is not for IBKR Lite. So if you're using that, I'd still almost always use limit orders. And I'd recommend in general just use limit orders whenever you're buying or selling stocks. But yes, I've found that unlike some other places out there that I've experienced with, they will. You don't feel like, hey, did they actually take advantage of me on this trade? If I made a little mistake here, they're not going to try to catch you off guard if you put in

B (19:44)

a bad order, if You're a regular listener to chitchat stocks, then you've probably heard us talk about Interactive Brokers. Here are three reasons why we think Interactive Brokers is better than any other brokerage platform. Number one, they've got it all. Stocks, bonds, ETFs, options, crypto, you name it. 170 markets, 36 countries, 28 currencies. Number two, they've got got best in class pricing. They have zero commissions on US listed stocks and ETFs and offer margin rates up to 54% lower than the industry. Number three, you can ditch the separate high yield cash account. Interactive Brokers offers up to 3.14 interest on instantly available cash held in your investment account. Head on over to ibkr.com Rate subject to change Margin involves risk restrictions apply. Interactive Brokers is a member of sipc. No, Exactly. They are genuinely customer centric. It seems the second sort of area of automation that's worth calling out is the margin loans and call process. So when you apply and receive a margin loan, the entire process is automatic. But importantly, the liquidation and evaluation process is automated as well. So they've built a system that constantly evaluates every account's risk and margin requirements throughout the trading day. If an account is getting close to falling below required maintenance margin, they provide a color coded cushion indicator to warn them. So it'll be like red, orange, yellow, basically like you're getting close.

A (21:09)

I've never gotten this so, you know, maybe one day.

B (21:14)

Then if you fall below your required margin amounts, the system automatically liquidates positions in real time to bring the account back into compliance. This is a process that, like margin calls generally across most brokers is a fairly manual process. It's, you know, there's someone that's actually evaluating it. So this is an area of automation that's a big differentiator. A couple other ones I'll go through real quick. And if you go to the 10k, you'll see basically every product or feature that they have is automated in some way. So excess fund sweeps. IBKR can automatically move cash between different account segments for you. So securities versus commodities, for example, to satisfy margin requirements. And then the fourth one is the Stock Yield Enhancement Program. Brett, I know you've taken advantage of this before. This system automatically manages the lending of your fully paid shares by identifying hard to borrow stocks in your portfolio that are in high demand by short sellers. So it'll automatically handle the loan logistics, provide collateral and split the earned interest with you. 50. 50.

A (22:27)

Yeah, if you're, if you're a Buy and hold person. It's free money essentially. If you're not someone that is worried about having to sell the positions anytime soon. I mean take advantage of that.

B (22:37)

Yeah, absolutely. So Brett mentioned it. Basically nearly 80% operating margins. How are they so profitable?

A (22:46)

It's.

B (22:47)

And Brett, maybe you can share some of the charts here that we've got. But a. These businesses in general are structurally pretty asset light like brokers, digital brokers specifically. They are. You're going to have generally high margins for any big broker of scale. But they are above and beyond all their competitors. So if you look at Interactive brokers operating margins vs Charles Schwab vs Robin Hood vs Coinbase Coinbase obviously different securities

A (23:24)

or

B (23:27)

tokens, whatever you want to call it, traded on the platform. But the business model economics should be similar. They are above all of them. They've got 77% operating margins. Schwab has 48%, Robinhood 47%, Coinbase 20%. And those businesses actually have more customers. Schwab, Robinhood, Coinbase, I don't know. But Schwab and Robinhood both have more transacting users or customers than ibkr.

A (23:56)

But ibkr, I believe Robinhood has much lower total AUM if you want to call it that. I think maybe, maybe. Let me confirm that you've looked this up, Ryan.

B (24:06)

I believe the account values are significantly larger on Interactive Brokers.

A (24:11)

Yeah, so that's probably maybe plays a part into it. But it's a great point. They have like okay, you can say all day, any company can say we're efficient, we're going to automate everything. We have 50 years of building these connections around the globe with financial markets and we run lean. We only have a really good tech team that's going to make things very simple for our clients. But we're going to be able to run with only a couple thousand employees compared to our competitors. But IBCare shows this in their margins which they've as they've scaled up you're seeing tremendous operating leverage. Let me note just things that I like to see them do as a customer or sorry as an investor as way because for example, you know a lot of these things eventually a Schwab, if they got their act together could catch up over time. But if you look at this recent press release from just a few days ago, Interactive Brokers said that they are enabling crypto portfolio transfers without having to sell and then rebuy once you open up an IBKR account. And they have the lowest cost in the industry, maybe not by far, but they claim to have the lowest cost for professional traders. So for anyone that wants to consolidate under one platform, you can do so tax free by doing kind of a account transfer over your crypto holdings to ibkr. And then they have the lowest cost for, for pros. So it is that value proposition that keeps growing and growing and growing.

B (25:38)

Yeah, and let me kind of put some numbers on this. So I guess a couple things that makes them so much more profitable, so much more profitable than those competitors. One focus, so Interactive Brokers is they are, they're exclusively a digital broker. That is their focus as a business. You compare that to like Schwab or Fidelity, those are more full service models with like wealth management services, which is fine, maybe you can earn more dollars per customer potentially on that, but structurally your margins are going to be lower because you employ more people, you have more costs. To give exact figures, Interactive Brokers has 3,182 employees. I believe on the last 10k that comes out to more than $2 million in revenue per employee. Schwab for reference has more than 33,000 employees or basically a third of the revenue per employee that Interactive Brokers has. The other one, and this is big and you've kind of alluded to it, is the direct access to exchanges. So this is perhaps the biggest differentiator. Most online brokers, like Robinhood for example, actually act as intermediaries that route customer orders to third party market makers. We've talked about this. Or centralized trading desks and rely on specialized clearing firms to handle the back office settlement for trades. Interactive Brokers has chosen to build a direct approach by purchasing memberships. Literally. Remember what Thomas Petterfeet did in the old days, paid 36,000 to be a part of the American Stock Exchange. Similar. So they purchased memberships on hundreds of individual exchanges in 40 different countries around the world. And then they're able to manage the process themselves. So now they offer access to 170 markets. I think Schwab for context has like 33 total markets. And although this is more costly up front, they're paying less in variable fees associated with each individual transaction, which helps benefit IBKR at scale. And then the third one, and this is, it's one of those things where you think like is that really a sustainable advantage? But they have had a general cost consciousness or sort of culture of frugality basically since the early days. And I'll give two clear examples of this in 2007 when Interactive Brokers went public, instead of paying the major fees that are required to go public through these bulge bracket investment banks. He chose a Dutch auction approach, which is apparently a more, I guess, democratic system and hired an obscure firm to list 10% of his business. That apparently saved him $80 million in the process. The second one here we're going to talk about this advertising. For a long time they spent literally nothing on advertising. Maybe they sponsored some events or something, I don't know. But there's no line item in their income statement because there wouldn't be much to report. Now they are starting to press the accelerator on this a little bit, although obviously still well less than 1% of revenue when think about that compared to like a Robinhood, for example. So they're spending nothing on advertising largely because throughout their history they've been the de facto platform for sophisticated or advanced traders and they didn't really need to. The product kind of spoke for itself, especially for that demographic. Now they can kind of press the accelerator, so to speak.

A (29:26)

One thing I'll add there is that they are moving towards individual traders and trying to compete more directly with Robinhood for example. They're going after people like us and they're going after listeners of our show. This isn't a show that, you know, we like to think that we. We're not the super basic investing, but we're definitely not tailored to sophisticated hedge funds or what have you. It's buy and hold, Motley fool style, Warren Buffett style, Peter lynch style. Peter lynch style. And they're advertising more towards that. Yeah, they're dipping their toe in the water by becoming an advertiser on a show like ours. But what's interesting is that in there was a article on a profile of Pedroffy on Colossus, the magazine Colossus, I believe it's called. You look it up Thomas Better if you Colossus, it'll pop up on your Google search results. He said he specifically focused on marketing right now. That's the next project he wants to solve and that he thinks that they can just keep scaling that as they find good roi, which makes me comfortable as one of their advertisers. I think we do a fantastic job for them obviously. But they only have as. Maybe we can share the chart here for what did you mention they only have 4 million active accounts versus hundreds of millions of a potential addressable market. Robinhood, Schwab, active accounts, Fidelity, what have you. And people have multiple brokerages out there. They are well, well behind the competition. And you can kind of see the inflection point coming out of the pandemic where more people started stock trading as well as when they started marketing. So I think there should be a long Runway to grow. Do you look at it any different Ryan?

B (31:11)

No, I agree. I'm just pulling up the numbers here and this is sort of a chance for us to plug fiscal AI as well. The total accounts has it looks incredible like just on a chart they've gone from I think around 200 million total accounts in 2012 to 4.4 million or sorry 200,000 to 4.4 million today. So 20x their customer base over 13 years. Yet like you said, it's seen a massive acceleration over the last five years. Specifically they there is hundreds of millions of accounts out there globally that they can go after and I think they've now really positioned themselves well to see a big acceleration in this specifically total accounts. Now they're not going to be all sophisticated hedge funds kind of thing, but you're going to have a lot more retail accounts now which still very beneficial to the business and there's virtually no increased variable costs to including more and more retail traders as well. And maybe I should mention there fiscal AI is where we got that total accounts figure. If you use our link in the show notes fiscal AI chitchat it'll get you 15% off any paid plan. Something you mentioned Brett, that I want to go back to the like companies can replicate in theory they can replicate some of these models, right? Think about like the smart order routing for example or whatever. Like instead of selling to one market maker, them going for the best execution. Why couldn't Schwab do that? There's nothing technically prohibiting them from doing it, but a lot of them are unwilling to because they're going to sacrifice a big profit pool for themselves. And these aren't owner operators. Schwab. Part of it's because they've been around for a century, they're not run by a founder. So there isn't huge insider ownership where you're willing to sacrifice short term profits in lieu of long term benefits. We saw this specifically during the Silicon Valley banking crisis. The Interactive brokers is now in a position where they have built these advantages that aren't necessarily impossible to replicate but competitors aren't willing to to replicate.

A (33:53)

I agree. Yeah, yeah that's a fair point. It's, it's not, it's sort of the innovator's dilemma but it's almost well we're going to go for the lowest cost product at yeah a lot of companies have gone commission free trading but the advent of high frequency trading and selling order flow has made that a little bit different. Where now it's about getting you the best pricing, not necessarily from a fee standpoint, but from actually, okay, what are you going to buy at the lowest or sell at the highest price when you send in that order? That's what they're optimizing for. I think before you get into their competitive advantage. The last thing I'll mention is that people, listeners to our show especially we're an English speaking podcast, we're from the United States, over half of our audience is from the United States. But Interactive Brokers is actually much more global than many listeners might think. Think because the value of a platform that can go global is much better if you live in a place like I always use the example, I don't know why, but Colombia, that one. If you can get access to the United States market is much more valuable than a United States person getting access to a market in South America. And that's true for the hundreds of different countries around the world that Interactive Brokers. You can get an accountant. You know, not everyone in these countries is going to want to invest, but for the people that do, IBKR is the go to solution. And there's likely not even nearly as the level of competition as in the United States. So again, the total addressable market for active accounts I think is much bigger than maybe some people think.

B (35:29)

Yeah, that's a really good point. And it's when I think of market coverage, like we advertise how much great market coverage they have for US Investors, that's kind of typically who we're speaking to when we say it's. But it's way more beneficial for the international investors. Like if you are in Japan having all these securities traded right there and being able to access the US markets and all these other global markets, that's way more of a, I guess, upsell than okay, I'm a US investor and they just added their 171st market. It's much more valuable to the 171st market and the traders in that region than it is to the US based account. Why do I call this the widest moat that no one talks about? So that is something. Well, I guess we haven't decided whether we're putting that in the title or not. But that's something I think is true when you talk about moats, not you. But when investors talk about moats, there's a lot of common companies that come up. Visa. And these companies deserve it. Visa, Moody's, Costco, Amazon, Taiwan Semiconductor, maybe asml. No one really mentions interactive brokers. And I think a big reason for that is because it's really competitive on the surface. But when you go under the hood and look for specifically for advanced traders, and now it's obviously graduating to traders all around the world and not even traders, investors, there are some things they do that are really, really difficult to replicate. Here are three things that I think give them a massive moat. The first one is this is a prime example of scale economy shared. That is the, the old nick sleep principle. So I'll give a quote. Scale economics shared operations are quite different. As the firm grows in size, scale savings are given back to the customer in the form of lower prices. The customer then reciprocates by purchasing more good, provides greater scale for the retailer who passes on the new savings as well. Yippee. This is why firms such as Costco enjoy sales per foot of retailing space four times greater than the run of the mill supermarkets. Scale economics shared incentivizes customer reciprocation and customer reciprocation is a super factor in business performance. Obviously this isn't a retailer, so the analogy isn't exactly apples to apples, but ibkr, we just talked about all the things they do to basically be the low cost provider. The automation, the general cost consciousness, the scale. At this point where they can keep their prices relatively low, they could just harvest those excess profits and keep them to themselves. Which this is wild to be saying for a company that has 80% profit margins. But they actually return that cost advantage to their customers in a number of ways. First one, when customers hold cash in their investment accounts, IBKR pays up to a 3.14% annual interest on those balances. At the moment I should say interest rates can change. Whereas most brokers pay nothing if you want to earn a little interest. And maybe brokers pay a little bit, but I think most of them pay nothing. If you want to earn interest, you got to put that cash into some short term yielding asset. Interactive Brokers takes it one step ahead and does that for you. The other one, and this is probably the single biggest selling point for a lot of customers, is they offer the lowest margin rates, I think of anyone in the industry. So the quote they have is IBKR's margin rates are up to 53% lower than the industry on average. And I remember I posted a chart that was like Interactive Brokers accounts versus Account growth versus Schwab. I was like why is this happening? And everyone's like, well they offer the lowest margin rates. I think it's a big selling point for a lot of people. Not really how I invest, but nevertheless this type of competitive advantage, this type of moat is probably one of my favorites where they're the low cost provider and then they reinvest the savings to benefit customers. Now maybe they could reinvest some of those savings into customer support. I've heard that's a big knock from a lot of customers, but they're clearly giving back through the form of lower margin rates and higher interest on cash. So that, that to me is when it becomes really hard for new players to catch up to the leaders is when they are using sort of the scale economy shared philosophy. I'll stop there. Any thoughts?

A (40:25)

Yeah, it's a balance between the customer support which maybe they'll automate with AI better, but if they can help them save on cost. As an investor, I have no problem with it. As long as they're able to keep adding active accounts and posting those margin rates. It doesn't look like anyone's too upset to want to leave the platform yet. Yeah, I got nothing to add. I think that that really covers the scaled economy shared and part of the competitive advantage. What else do you have for this widest business that no one talks about?

B (41:02)

This episode is brought to you by Indeed. Stop waiting around for the perfect candidate. Instead, use Indeed sponsored jobs to find the right place people with the right skills fast. It's a simple way to make sure your listing is the first candidate. C According to Indeed data, sponsored jobs have four times more applicants than non sponsored jobs. So go build your dream team today with Indeed. Get a $75 sponsored job credit@ Indeed.com podcast. Terms and conditions apply. Sometimes you just want a good story on TikTok. You'll find short dramas emotional fast and impossible to stop watching. Download TikTok now. The second sort of pillar, and we've already talked about this a bit, is the whole global markets thing. So they offer more markets, more geographies than I think any other mainstream broker. Like maybe you can get better market coverage from your prime investment bank broker who's going to do it manually and charge you a bunch. But in terms of mainstream brokers, they are the widest coverage. What does this actually mean? Because I kind of thought like well why doesn't Schwab just do this? Like why don't they just buy it? Buy a bunch of different markets and give access. Adding a new country is not as simple as flipping a switch. Apparently it's a multi year often Negotiation that involves a bunch of major hurdles. So one, there's regulatory licensing. Brokers have to acquire the appropriate, appropriate regulatory licensing for each individual market. That means hitting certain capital requirements. It means specific reporting standards. The second part is the technical integration. Every exchange uses different languages or protocols for their data feeds and order routing. That means engineers have to build custom bridges to the exchanges APIs to ensure that when you click buy, the order travels halfway around the world in milliseconds. The third one, clearing and custody. When you buy a stock, someone has to hold it. So to solve this, IBKR either becomes a member of the local clearinghouse or sets up a relationship with a custodian bank in that country to hold the digital certificates of stocks. Ultimately, this is sort of the complexity and boredom that a lot of other brokers simply aren't willing to go through. So they don't want the legal head, the legal headache of filing tax paperwork in 30 different languages or the risk of holding assets in volatile emerging markets. IBKR for the last 30 years has embraced this complexity because once they build that quote unquote pipe or that that new market, it costs them almost nothing to let more users trade through it. So again, high fixed costs to get set up in certain markets, but you reap the benefits as you scale in both in those markets and having other traders place transactions in those markets.

A (44:06)

Yeah, it's a good point. It's not that valuable for someone. Again, we use the mainline brokers, Vanguard, Fidelity, Schwab. If you're just, you just want people to put their assets there on your platform, buy ETFs, just buy QQQ and SPY and your index funds and do your wealth management services that are just going to track the market. You don't. Why do you want access to direct access to Japan? But for interactive brokers, they see that as a value proposition for their core customer and something that they can convince someone like Ryan and I to switch over to their platform if you get frustrated by not having access to international markets.

B (44:45)

The last one I'll mention is execution. We already talked about it, so I won't go too long. But I think there's sort of a misnomer around commission free trading and some people might already know sort of the payment for order flow process. But for a while I think there was sort of a knock on IBKR that well, they're still charging commissions for trades in a world where IBKR or Robinhood's giving them away for free. As you learn more about payment for order flow. And I think as Traders, traders or investors or people kind of become more privy to what's going on behind the scenes with payment for order flow, they actually tend to appreciate fixed commissions. So for example, on if let's say you had a bigger account and you placed a $50,000 trade that commission, that the hidden costs in the payment for order flow could be 100, $250 somewhere in there, as opposed to the $6 or whatever you'd pay in the fixed commission. So the no commission can be nice for smaller accounts that are growing. But IBKR actually offers both. You can have IBKR Lite, which is commission free, or you can have IBKR Pro, which is fixed commission. And they said most people actually still prefer to have the fixed commission. Now maybe that'll shift a little bit over time as they get more sort of retail or individual investors as opposed to the funds that they sort of built with over the last 30 years. But I think it's an important distinction and they really go through the fact that they offer both, I think shows you the transparency that we're going to give you the best option, whatever is best for you, as opposed to hiding anything like some of these other brokers do.

A (46:41)

Yeah, that's a fair point. Yeah, I think it's more of the focus on the customer that is what at the end of the day is going to lead more people there and just given their better overhead cost management, they're going to generate a lot of profits. And if you focus on that, I think the best businesses generally are the ones that win out over the long term because they treat their customers right and that's going to lead to get shareholder performance or performance for shareholders.

B (47:10)

Okay, let's talk new expansion opportunities. I want to give a quick shout out to you, Brett. These were. I didn't really think about these until I read your write up on Interactive Brokers, which for anyone that hasn't checked it out, he has a good write up on the Emerging Modes newsletter that was I think in January or February. And I actually relied on a lot of the research for this episode. But there's a few tailwinds that I think will be big expansion opportunities for interactive brokers. The first one, forecast contracts slash prediction markets. Sort of the same thing. This is another way for them to drive transactions. And I know when I said prediction markets, some people maybe roll their eyes or groan because they picture like degenerates betting on the weather for the day. But this is a way, if you have a differentiated view on a stock, let's say, or an upcoming earnings report. This is a way to express that view, especially for certain funds. And I know this feels a little unfair to the individual trader, but let's say there's a KPI, for example, that a fund tracks really well. And maybe they. Some funds do this by the way. They put satellites up, they know inventory for certain places, they know whatever volume for certain locations, that kind of thing. They could in theory have sort of an informational advantage there and bet on specific contracts like that through sort of these forecast contracts. There's a lot of other ones as well. Like you can do whatever. Will the s and P500 be above a certain amount by the end of the year or the quarter, whatever. Ultimately this will just, I think drive higher transaction volume. And I actually believe it will help attract new customers as well that are maybe averse to the like more gambling

A (49:12)

focused prediction marketplaces that are like, okay, Ryan, it's gambling. There's just another way for them to make money. They want any asset on the platform. I think that's it. They want any whatever asset you can trade legally, they want it on the platform.

B (49:26)

To be clear, there is not sports betting on the interactive broker. One.

A (49:30)

That's fair. That's not an asset though. That's true, you know.

B (49:34)

Yeah, I think they're.

A (49:35)

I think there may be waiting and yes, sports is a bit different, but maybe they're waiting for the legal stuff to play out because there's still a lot of. To be determined within that market.

B (49:47)

Yeah. And it's actually been fun to kind of watch this evolve because when they first launched forecast contracts there was a lot of limits. Like there was only so many forecast contracts on there. Now if you go visit it, way more volume. So way more people betting on these contracts and way more contracts themselves. The second one, I think this is maybe my favorite one. 247 trading. It feels this has been discussed for maybe like a decade now. I think it's more and more likely that it's going to happen. And by the way, I will say I'm all for this. I don't know why people have gripes with 247 trading.

A (50:24)

Yeah, I guess. Yeah. Unless you're someone that's glued to your screen, if you just check your account once a day, there's nothing wrong with that. But does it need to be open for that long? Probably not. It's better for interactive brokers though.

B (50:39)

But unless I'm wrong, there's no like this is kind of an antiquated system to have it 9 to 5 or 9 to 4 or whatever.

A (50:48)

Yeah. I think there's no reason it can't be open 24 7. I think people just think of like not more, maybe not morally, but they just see that just could have some downstream side effects that are negative if it causes people to be addicted to this like with crypto. But that doesn't mean it shouldn't be available. You just gotta be disciplined.

B (51:11)

As someone who doesn't check their portfolio that regularly, it's really annoying when I miss the time cutoff to like add shares in a day. I'm like, you're kidding me. Whatever.

A (51:22)

I'm a once a day guy. Once a day guy? Yeah. I always gotta do once a day anyway.

B (51:27)

I mean I don't see any downside for to IBKHLR for 247 trading. It just means more transaction volume means more revenue for interactive brokers. And then we already talked about this but the third one for me, expansion opportunities is global expansion. So adding more markets. They've got a few I believe slated for 2026. And I know if you're in the US you think what's the, what's the big deal? Okay, now they've got 171 markets. Great. Now I can look at stocks in the Philippines but for the Philippine investors it's a huge deal and it helps with account growth for interactive brokers. And then the last one, I'll say here, we've kind of alluded to it and this isn't like an expansion opportunity I guess, but they have done a really good job. So historically they've been really positioned or geared towards funds and professionals and that's the market that they've basically won. But now I think they've done a great job taking that world class digital infrastructure, smart routing technology and positioning their product for individual investors as well. With IBKR Lite, IBKR Desktop. So not having the, I think that's the naming where it's web based as opposed to the application itself, crypto products, mobile app. They are doing a better job being an app that's accessible to someone graduating from Robinhood who doesn't want a full blown terminal. Would you agree with that?

A (53:01)

Yeah, that's fair. They launched IBKR Lite in 2019. It was in reaction to everyone going commission free. It's probably a smart move and I think it's working well. There's no reason anyone that uses Robinhood these days unless you have that full financial services aspect. And the not, not the wealth management but the credit card stuff and all of that. There's no reason someone would go to Interactive Brokers now and go, hey, I'm missing something that was on Robinhood. Whereas if you go the other way

B (53:36)

around, unless you're a sports bettor.

A (53:39)

Yeah. Do they have that on Robinhood now? They have a Calshi or Poly Market partnership. Yeah. Well, they'll lose that customer. It's okay. I'm not sure they're that profitable.

B (53:48)

No, probably not. Let's talk valuation. I think this is probably the most actionable part of the discussion today. So important thing to understand here. IBKR has a bit of a complicated ownership structure. There's an IBG holdings where Peter Fee and I guess some other people hold a class B common stock that is not available to minority shareholders and that grants them, I think basically 75% of all the voting power. The important thing here is a lot of the aggregators have the data incorrect. The market cap that you as investors are really looking for is going to be the implied market cap. So it's going to be the class B plus, the class A. So to illustrate this point, the consolidated net income for Interactive Brokers last year was $4.4 billion. Net income attributable to common shareholders was $984 million. So you want to use the implied market cap plus and divide it by the consolidated figures. I'll go through some of the numbers, but I know that's complicated. If you go to the 10k, there's a diagram that shows the ownership structure. The important thing to understand here is it's Petter fe's company. He owns it, he's got all the voting power.

A (55:14)

And just make sure you get your market cap right. But don't worry. Yeah, Peter Fee controls everything. But at the end of the day it comes down to you trust the company and the executive team. So just don't get fooled and thinking the market cap is much lower than it actually is.

B (55:28)

Yeah. Yes. Double check those figures. So anyways, implied market cap is currently $108 billion. They generated 4.8 billion in operating income over the last 12 months. So face multiples market cap to operating income 22 times. I'm now going to read a snippet from Brett's recent write up. He says if you take a longer view, any confidence in sustained account growth at current levels could make IBKR a buy today. 30% account growth for the next five years. Remember, Peter Fee is promising this as long as he's still alive. Sidebar here in the last conference call they asked this is really good account growth. How long do you think this can last? And Peter, if he said as long as I live so he's confident that he can continue to grow accounts and

A (56:18)

he is over 80 so it's not like it's going to happen for decades. Yeah, 10 more years. Maybe 10 more good years.

B (56:25)

Yeah. Hopefully. Continuing on with Brett's quote, this 30% growth over the next five years would lead to 16 million total accounts five years from now. Honestly, I do not think this is an overly bullish expectation. Given the addressable market is in the hundreds of millions. That would be 3.7 times the current customer count. Sprinkle on some inflation and per user transaction growth and revenue could scale five times over the next five years in a bullish scenario. He also says I don't think this would happen in a prolonged bear market. We can talk about that in a second. A stable pre tax profit margin would yield $24 billion in annual operating earnings five years from now. As I write this, it feels overly bul but I don't think it is impossible. I agree. I totally agree with it. To me it feels crazy to say, but I don't think going from 4.8 billion in operating income to 24 billion in operating income in five years is entirely out of the question. I do agree that saying it out loud makes it sounds feels optimistic.

A (57:31)

2021.23 billion. 2015460 million and 2025, 4.8 billion. The trajectory isn't off. But yes, 2020 to 2025 has been a great, wouldn't you say coming out of the pandemic outside of the 2022 period. It's been very nice time for equity trading. Financial assets.

B (57:55)

Yeah. And I think they have done a really good job. We talked about this positioning themselves for individual investors as opposed to being a too intimidating of a platform, too complex of a platform which maybe people thought it was 10 years ago. That doesn't seem to be the case anymore. And actually if you look at some of the. I'm sure they talk about this as well but if you look at like transactions per account, it's basically been cut in half over the last 10 years. So that tells me that. And I'm sure you could find like deposits per account as well. But it tells me that they're skewing more and more towards individual investors as this account growth is starting to just balloon. So I think they're in the early stages of their growth curve. I think they've got a cost advantage. I think they are pressing that advantage now with focusing on Marketing and going and getting at new customers. I am an uncomfortable, I am comfortable with the valuation. So I plan to add more shares. I will wait until we have our little, our clearance period.

A (59:04)

Were you already a shareholder coming into this recording?

B (59:07)

Yeah, it was a tracker position.

A (59:11)

I mean I think it's like over 5% of my portfolio. It's one where I think they're not going to blow up during a market downturn. So the stock tends to be very pro cyclical to how the broad market performs. So if we get a bear market, that's where I feel like the opportunity to double down is. You're not going to take out new lows. Maybe not compared to the April 2025 period or the especially now the 2022 period. But you know, that's maybe where the buying opportunities might lie. And it's one for me that I would like to make one of my largest positions in a bear market today. You know, it's a decent sized position but again we're at a PE of 30 so it's not something I want to go, hey, this is. And it could be elevated earnings if we go into an extended bear market. So I want to keep it balanced. At least that's how I look at it. Maybe you look at it differently.

B (60:07)

No, this is the kind of. I don't want to miss the opportunity to own Interactive Brokers when I think there's a realistic possibility to go from 5 billion to 25 billion in operating income. But this could get earnings could get cut in a bear market and I would be much more excited to add shares in a bear market. The last thing I'll mention here, if you go to fiscal AI and you look up interest income for Interactive Brokers versus Schwab over the last like four years. Three years. Four years. This is a very good showcase of the benefits of having an owner operator at the helm. And keep in mind Schwab people were saying it might go under three years ago. I think people forgot about this. But Interactive Brokers they were very patient with. So basically with cash held they're able to invest it in various assets of brokers. They can. In the case of ibkr I believe it was pretty much like one month or three month Treasuries. So super short term assets. Schwab was getting impatient. They weren't hitting their or they needed to reach for yield in order to meet some of their compensation hurdles. So management started getting into riskier assets, longer dated assets. They were doing mortgage backed securities. I think they had 15 year bonds trying to reach for yield to hit income thresholds. When interest rates spiked, all those assets were basically underwater. Lucky that they don't have to mark to market them or mark them as down. They can hold to maturity but they are obviously worth significantly less when interest rates go up. So there is the chance that you have another 2022 like 2023 like scenario with Schwab. That just leads to a bunch of account growth for a platform like Interactive Brokers.

A (62:05)

Yeah. Nothing else to add on my end. I think the main takeaway for me for valuation is that on a long term time horizon I feel like it's cheap. It looks like it's fairly cheap. Even though the PE ratio is 30 today, their potential to grow is outstanding. But there are risks with that. They may not hit those numbers and we are in. Despite this recent correction, it's still a pretty aggressive bull market. Valuations are very stretched. So there could be better opportunities ahead. So you got balance that as an investor. Make your own decision with that.

B (62:42)

All right, I think that's going to do it. Thank you to everyone for tuning in. Brett, any any other closing thoughts or are we good to wrap this up?

A (62:51)

I just say thank you to our sponsor Interactive Brokers. I will reiterate that I the investment decisions and any sponsor we have is the only one that's really going to until fiscally I goes public and Ryan gets rich, that's the only one that's going to have a, you know, any sort of conflict of interest there. Again we have them as a sponsor. It's totally separate from any individual stock portfolio decisions we make. And yeah, I think great episode. Let us know any other stocks that you want us to research on the podcast. And as Ryan mentioned, I do have that paid research service, Emerging Moats. The link is in the show notes. Check it out. You can read the IPKR one and if you want a free trial I will give you that as well. Anything else from you Ryan or should I hit the disclosure and we can get out of here?

B (63:38)

No, I 100% recommend people utilize the free trial. There's now Brett's done this for I think almost six months now. There's a great back catalog of research on a lot of exciting companies, Interactive brokers included.

A (63:52)

Mercadolibre coming Friday as well. Going to be a nice comprehensive research report there.

B (63:57)

Nice. I think that's going to do it. I can hit the Disclosure. Thank you everyone for tuning in. We want to remind listeners that Brett and I are not financial advisors. Anything we say here on Chitchat stocks is not formal advice or recommendation. We may buy, sell, or hold any of the securities discussed in this podcast. So please do your own research. Thank you again. We will see you all next time.

A (64:32)

I finally had a light bulb moment

B (64:34)

about a stock we've all heard about growing at 18 a year and a 15 pe. I shared this insight in a special Deep Dive report to subscribers of my research service, Value Spotlight. The report is called A Generational Moment, Reigniting Human Connections through a Tangible network of Intangible assets. Chit chat listeners can get a discount to my research@stockwriteup.com that's stock W R I T E U P dot com.