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

The Daily Telegraph - Business - - Business -

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.

risky buy

Questor says: Ticker: IGG

Share price at close: 819p

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