IG Group’s adaptability and financial strength suggest it merits a premium valuation
Other firms may hate the prospect of rocky stock markets in the months ahead – but not this derivatives trader, writes Robert Stephens
FEW investors will be surprised to learn that stock market volatility recently reached its highest level since the darkest days of the global financial crisis.
The “Vix” index, the market’s so-called “fear gauge”, which represents investors’ expectations of volatility, rose from 12 points at the start of the year to 82 by mid-March as the pandemic swept away previously bullish forecasts for the economy and stock market.
Even after the recent rally, the index is still 160pc higher than at the start of the year. This suggests that investors continue to be extremely nervous about the future.
While high volatility may be bad news for most stocks, it is anything but for derivatives trading businesses such as IG Group. It has historically gained
more new customers and enjoyed more frequent trading from existing ones when the stock market is at its most volatile.
For instance, in its latest quarter, to the end of May, the firm recorded 120pc revenue growth relative to the same period last year.
Questor believes that the prospect of persistently high volatility in the second half of this year could contribute to continued strong trading conditions for the business. Not only is the first wave of Covid-19 showing little sign of ending but the prospect of a second wave in Europe, Asia and elsewhere could lead to heightened fears among investors.
In addition, political risks such as Brexit and November’s American presidential election could keep volatility elevated into next year. Likewise, tensions between China and America could prompt traders to be more active in volatile markets over an extended period. IG’s business model not only allows it to benefit from higher volatility but has also enabled it to operate without disruption during lockdown. Past investment in technology has allowed all employees to work from home, while innovation has broadened its product range to improve its market position through appealing to a wider pool of customers.
Most of its revenue is generated by repeat business from clients who have been with IG for more than three years. Its plans to diversify geographically should reduce its dependence on mature markets and give it exposure to the growing incomes of consumers in emerging markets such as China.
Considering that the firm’s business model focuses on offering leveraged products, its balance sheet is in surprisingly good shape. It has a debtto-equity ratio of just 15pc, while a yield of 5.3pc could entice income investors at a time when dividend cuts have become commonplace.
Unsurprisingly, improving financial performance has led to a sustained rise in the share price since the start of the year. As a result the stock now trades on a price-to-earnings ratio of 19 at a time when many other FTSE 350 stocks offer far wider margins of safety.
IG also faces an uncertain economic outlook in many of the countries in which it operates. This could lead to rising bad debt provisions and reduced disposable incomes among clients, limiting their ability to trade.
Meanwhile, regulatory risks are an ongoing threat across the derivatives trading sector. This challenge is likely to persist, although the company’s diverse geographic spread may help it to overcome sudden, unexpected changes in specific countries.
The company’s annual results are due this week, so volatility in its own shares could be ahead. However, in Questor’s view the firm’s growth prospects outweigh the risks that it faces.
In a period when significant political and economic challenges could push the volatility index to new heights, IG may be one of the few stocks to benefit. Its adaptability and financial position suggest that it deserves its premium valuation.
Questor says: Ticker: IGG
Share price at close: 819p