How IG Index creams 50% profit margins

Recently, I’ve talked a lot about volatility. How, in an effort to control the markets, central planners destabilise the whole financial system.

The problem for most investors is that they react to volatility in exactly the wrong way. ‘Buy the dips, sell the peaks’ sounds good in theory, but in practice, it’s one of the hardest things to do. Who wants to buy when everyone else is selling and the market’s going down the pan? It’s tough!

Today, I’ll show you one way of harnessing market volatility, without the need to endure this emotional rollercoaster.

Let the professionals take care of it

IG Index, the spread bet provider, released its latest results yesterday. Now, here’s a company that really thrives on market volatility. Since IG gets a cut on every trade, it doesn’t care what direction the market is moving. Just as long as it’s moving. Having suffered a pretty uninspiring first half, it had a great second half on the back of higher market volatility.

I first talked about IG a couple of years ago when it was around the £4.50 mark. The shares have performed pretty well in the mean time… up to about £6. Not bad, given that it’s been throwing off a yield of about 5%.

A stock that can make money whichever way the market goes is obviously welcome. And volatility is IG’s friend in another way. IG customers usually use leverage to amplify wins and losses, and stop losses to protect themselves from big losses. Volatility sends punters crashing into these stop losses… and IG reaps the rewards.

But IG is not just well placed because I think volatility is here to stay, it looks like the business could be set to get stronger…

Margins are going up

Because of the ‘boring’ first half, overall revenue saw a small drop from £400m to £398m. But because of cost cutting, such as cutting staff bonuses, the business still managed to grow the bottom line.

Operating profits came in at £192m against £185m last year. The more observant among you will notice immediately what a massive operating margin (operating profit over revenue) this business generates.

As is clear from the following table, IG was able to increase margins in all regions of operations, except ‘rest of world’ – where, to all intents and purposes, margins were flat.

Operating profit margin by region
Segment 2013 2012
UK 59.1% 55.9%
Australia 65.0% 62.2%
Europe 37.5% 36.2%
Japan 45.4% 37.4
Rest of the world 35.1% 35.2%
Group 53.0% 50.6%

 

Source: IG Index report and accounts 2013

IG earns serious money, especially in the UK and Australia (bear in mind that supermarket operating margins are nearer 5%!).

According to its management, IG makes fat margins in the UK and Australia because these are mature markets. Margins in Europe are less exciting because of a larger marketing and infrastructure spend. So the obvious implication is that IG hopes for higher margins in the European businesses as they mature.

So the big question is…

Is IG a buy?

As I mentioned before, IG’s shares have done well lately. Though the dividend has consistently risen, the share price has risen faster, so the yield has fallen from 5% to 4%.

That’s still a good deal better than you can earn on cash. And seeing as the company has a policy of paying 60% of profits to shareholders, as profits have grown, the dividend has followed. To my mind, IG still offers reasonable value as part of a diversified portfolio. At 15 times earnings, it’s not dirt cheap… but then again, right now, not many good stocks are!

There aren’t many companies I’m happy to hold in the financial sector, but this is one of them. The potential to earn money in a bull or bear market is clearly a fantastic attribute. And the fact that IG profits from volatility is another fantastic quality.

Of course, there are risks. As part of risk management, the firm has a lot of hedging activity. That means it lays off exposure with other members of the finance industry. IG has hundreds of millions of pounds of exposure to other counterparties – if one of these counterparties gets into trouble, IG could lose a lot of money.

Then there’s legislation. One of the main reasons spread betting is popular is down to the tax advantages it offers. This can easily be legislated away.

The second big advantage spread betting offers customers is leverage. Again, leverage can be a dangerous tool. Over time, regulators may want to get involved.

Over the long run, IG has shown an ability to roll with regulatory changes and come out on top. In many ways, regulations help keep competitors at bay. Perversely, regulations often hamper business start-ups and actually end up hurting consumers. Still, that’s not IG’s fault. But it does help protect these fantastic profit margins.

Overall, IG is a buy… not a compelling, strong buy, but a buy nonetheless.

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  • eddiegeorge

    Hi Bengt,

    Interesting that the 2 comments posted earlier today which revealed some IG creaming tactics appear to have been removed…….

  • Red7

    Bengt
    Obviously IG make money on the spread between buy and sell price of each trade placed by their clients. This spread is from 1 pip in a large open forex market such as Cable (gbp/usd) etc. to maybe 6 pips in US Oil or Dow during out of hours trading.
    So for an average trade of say £3 per pip (this would be the equivalent of buying or selling approximately £45k of stock in the Dow) IG would make roughly £10 on the opening and closing of that trade. And good value for money in itself for being able to take that size position.
    To turn over hundreds of millions that’s an awful lot of trades processed.
    Bengt
    Do you see IG as totally neutral in their relationship with their clients ?
    By that I mean do they just make their money from spreads ?
    This is an important issue with regard to your article and the quality of the investment.
    Without doubt some Spread Betting providers have been accused of being less than honest with client positions ie. manipulating prices and taking out client stops which are on view to them.
    Do you consider IG to be honourable in this respect ?

  • mr

    I use IG. I have sometimes wondered whether they or other spreadbetting companies ever take out stops by manipulating prices. I have no reason to think they do. I did once get stopped out in a FTSE100 stock within seconds of the market opening by a swift drop of over 2% in the price which recovered in another few seconds. I complained to the company who investigated and told me the stock had actually traded at that price. I also asked the Stock Exchange to investigate and they saw no reason to question the price move, whatever that meant!

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