IG Group is a world leader in online foreign exchange (forex) trading, spread betting and CFDs (contracts for difference) and it’s a stock I’ve owned for about two years.
I bought into the company at 603p in 2014 and since then the shares have risen by almost 60% to 960p today. That’s a healthy gain by any reasonable standard, but despite this increase I still think the shares are attractively priced.
However, if the shares keep going up at 30% a year I don’t think they’re going to stay attractively priced for much longer, so I thought I’d write a review before they vanish outside of my “defensive value” criteria.
Leveraging its world #1 status to produce consistently good results
The IG in IG Group stands for Investors Gold and the company started out in 1974 as the UK’s first spread betting firm. It did this by allowing traders to place “bets” on movements in the price of a gold index, rather than having to deal in the underlying commodity.
IG’s position as a pioneer continued with further innovations during the 1990s such as spread betting on equity indices and individual shares, as well enabling trades to be placed on the then newfangled World Wide Web.
This leadership position has led to rapid growth over a long period of time, including the last few years.
Here are some of the key stats for IG Group’s fundamentals compared to the FTSE 100 (although IG Group is listed in the FTSE 250 I tend to compare everything to the FTSE 100 for the sake of consistency):
- 10-Yr Growth Rate = 9.8% (FTSE 100 = 1.7%)
- 10-Yr Growth Quality = 88% (FTSE 100 = 50%)
- 10-Yr Profitability = 26.1% (FTSE 100 = 10.9%)
In terms of output then, IG Group is far above average. But what about inputs?
I’m primarily interested in inputs that generate relatively fixed future obligations such as borrowed money, staff (specifically their pensions) and capital assets (buildings, machinery, etc.). A little of these inputs is often necessary, but too much can be dangerous.
For IG, these inputs appear to be either non-existent or small, which is generally a good thing.
Little or no debt, pension and capex obligations reduce risk and increase cash returns to shareholders
Starting with interest-bearing debts or borrowings, IG Group simply doesn’t have any. That certainly reduces risk but most companies are operationally more efficient if they use at least some amount of debt to expand their operations.
However, I’m not going to complain about IG’s debt-free position.
Turning to pensions, I’m interested in knowing how large a company’s defined benefit pension liabilities are, and thanks to a certain Mr Green these pensions are certainly a hot topic at the moment.
But again for IG things are very simple. It doesn’t have a defined benefit pension scheme and so there is no risk from a pension deficit or any potential changes to the law regarding dividend restrictions when pension funds are in deficit.
In terms of capital assets I like to look at how much a company spends on capex relative to both earnings and depreciation. The capex/earnings ratio measures how capital intense the business is while the capex/depreciation measures how rapidly the company is expanding its capital assets.
IG’s ten-year capex/earnings ratio is just 8%, which is extremely low (most companies are in the 50-100% range). That makes sense though as IG is primarily a technology company and doesn’t have to invest heavily in physical assets such as buildings or machinery.
With such a capital-lite business the capex/deprecation ratio hardly matters, but just out of interest the ten-year ratio is 81%, so there is no obvious rapid expansion of what few capital assets the company needs.
The result is a company with a low risk, low cost balance sheet which means large amounts of cash (about 65% of earnings on average) can be returned to shareholders rather than being used to pay off debt interest, pension deficits or capital assets.
So far IG seems to be a company with a lot of internal strengths and few obvious weaknesses (although there are always weaknesses somewhere), but what about external opportunities and threats?
Future growth opportunities will primarily come from international expansion and adjacent markets
In terms of opportunities for future growth, two main routes are being taken.
The first is to continue the company’s existing successful policy of international expansion (the company already has offices in almost 20 countries and via the web can provide services to traders in many more).
IG’s vision is to be “the default choice of active traders globally” and to keep growing rapidly it has to think globally as it is already the dominant market leader in the UK.
The second route to future growth is to expand into markets that are closely related to its core leveraged trading products, namely unleveraged trading and investing via its new IG share trading business.
This new service allows investors to buy and sell shares and ETFs directly, rather than just betting on movements in their prices (i.e. spread betting).
It gives investors the usual options including a trading account, an ISA account and even a SIPP account (administered by a third party). This puts it squarely against the existing major execution-only stockbrokers such as Interactive Investor, A J Bell and Hargreaves Lansdown.
The point of all this is not just to run a profitable stockbroking business, but also to attract clients who might not have thought about opening a spread betting or CFD account before.
The company is of course offering beneficial terms if a spread betting or CFD account is opened alongside the share dealing account, and it will be interesting to see how many investors end up at least dabbling in the world of trading.
The other adjacent market that IG is moving into is ETF-based model portfolio investments, which will cater to yet another type of investor who may not have thought about the wonders of spread betting.
This new business is called IG Investments and will be run in conjunction with Blackrock. I assume this means it will be similar to Blackrock’s model portfolios, perhaps including an ETF which is split 50/50 between global stocks and bonds and rebalances automatically.
With these two routes to future growth I don’t see any obvious reason why IG Group can’t continue to grow at close to 10% a year, although of course nothing about the future is guaranteed and there are potential threats.
Regulation is a major uncertainty and potential threat
All of IG’s core activities are highly regulated and changes to those regulations will impact IG to a potentially large extent.
One example is the recent UK/EU referendum, where as an EU member the UK’s financial companies could operate in the rest of the EU via a “passporting” system.
Once the UK leaves the EU this will no longer be an option (unless the EU and UK come to some sort of special arrangement), so IG may have to set up subsidiary companies within the EU in order to operate there.
Another example would be the EU Financial Transaction Tax (EU FTT) which, if it ever sees the light of day, could massively increase the cost of each trade and therefore massively reduce the number of trades placed, which is the whole point of the tax.
This could be very bad for IG’s operations in any countries that introduce such a tax.
One final example would be the recent French and Belgian proposals for restrictions on leveraged products (e.g. spread betting) and their marketing to retail investors. Again, such restrictions would be bad for IG in these countries and any other countries that go down that path.
IG Group’s dividend yield may not be high, but I still think the shares are good value
In summary then, I like IG Group, I think it’s a good company with lots of strengths and good opportunities for future growth, but of course there are risks and threats too.
The share price is 960p as I write, and that gives the shares a dividend yield of 3.3%.
That’s below the FTSE 100’s 3.7% yield (at a price of 6,830) but I think IG Group’s track record and potential more than make up for that minor dividend deficit, although of course that’s just my opinion.
As I said at the start, I’ve owned IG Group for two years and I don’t expect to be selling it any time soon, unless the share price continues to go up at an unreasonably rapid rate over the next few years.
[Disclosure: IG Group is also a holding in the UK Value Investor model portfolio]
You are giving important information for free!?!
Obviously there is a regulatory risk, but I do not think a regulator can stop people from (spread) betting. This company is leader in the sector.
In my view it is better to have it in a diversified portfolio than a proper betting company like William Hill.
Like alcohol, tobacco and defence stocks, there is always a place in the portfolio for this. It makes the portfolio better!
Have a good weekend!
John Kingham says
Sometimes the best things in life are free!
In terms of regulation, it’s more that some countries are looking to restrict advertising to retail investors, just as they restricted advertising for smoking many years ago.
But the tobacco companies are still doing well and I expect IG to do the same for a few years yet…
John – Couple of potential caveats :-
1. This is spread betting company and it potentially harbours huge exposure via the activities of it’s members. Here is an example of what exposure the organisation had last year when the Swiss Central Bank floated it’s currency :-
“”The spread-betting giant IG has admitted that it may never claw back most of the £18m lost by its clients after the Swiss scrapped their currency ceiling – and now its credit controls are under scrutiny. Russell Lynch investigates””
2. Deutsch Bank is possibly on the verge of collapse, given that it’s derivatives book is 10 times the size of that held by Lehman, just before it was declared bankrupt.
If Deutsch or an Italian Bank goes — this could collapse IG and it’s underlying trade activity.
3. For a company that purports to have no debt, it seems to spend a lot of it’s cash servicing financial activities (£105.4M) against a net cash flow from operating activities of £184M.
4. IG’s share price isn’t particularly cheap, when considering in 2011 it had a P/E of 11.4 and a growth rate of 15% — giving a PEG of 0.7.
Today it’s 19.5 with a growth rate of 6% — The PEG is 3.0 — a very different picture.
LR — Nice company, but not a sure fire bet I suspect — but then I suspect nothing is on the sock market.
John Kingham says
Thanks for highlighting those points. Taking each in turn, I think:
1. SPREAD BETTING – agree that there are risks and the EU referendum was another big one. However it does hedge its exposure a lot and the company has decades of experience in these matters, although of course that doesn’t mean something couldn’t go wrong.
2. BANK COLLAPSE – Agreed again, but I would label this as the sort of systemic risk that all companies face (and all people for that matter). My defence against this sort of risk is company/sector/country diversification.
3. FINANCIAL COSTS – £100m of that £105.4m is dividends to shareholders.
4. NOT CHEAP – Cheapness is in the eye of the beholder! By my metrics it’s cheap, so I say it’s probably cheap. If you use PEG or some other ratio, which is of course entirely reasonable, then that other ratio may disagree, which is fair enough. I guess PEG-based investors won’t be buying IG, but that doesn’t impact what I’m doing.
So those are all valid points but there’s nothing there to make me change my mind, although I am entirely open to changing my mind if I think it’s the right thing to do. I am certainly not dogmatic at all.
Finally, you are of course right that it’s not a sure fire bet and that there is no such thing in investing. The sensible answer to that annoying fact is to diversify, diversify and diversify again.
Thanks for your comments as always LR.
I like it except for the price to free cash flow which is a little high at 29 using averaged data ( similar to PE vs PE10 but I use 5 years to increase sensitivity to recent data). If I bought it I wouldn’t expect there to be much more upside.
John Kingham says
Hi Andrew, I always look at free cash flow for each company but so far haven’t found a way to use it that I like, so I tend not to mention it.
It can be pretty volatile from year to year, so your averaging approach certainly makes a lot of sense.
I guess I sort of look at free cash flow but from a different angle, primarily through things like debt, pension deficits and capex, which can affect cash and profits differently.
Hopefully the outcome is the same, i.e. low cash/pension deficit/capex companies tend to have lots of spare cash to return to shareholders.
That’s the idea anyway.
Another way you can look at cash flow is fcf/sales. That tells you how much of the income a company takes in gets turned into cash for shareholders. IG group scores highly on that measure so on balance I would probably buy it.
The presence of free cash flow indicates that a company has cash to expand, develop new products, buy back stock, pay dividends, or reduce its debt. One thing that this company does not have is debt (and a defined benefit pension scheme) this is an important consideration. It is not good to have a company with high free cash flow now but with huge debts to be repaid in 2 years or with a pension scheme with a £500m deficit.
My view is that there is potential upside from the new products already lauched or to be launched. I can see this company evolving from a very good spread betting company to a platform that offers access to buying shares (and even funds), engage in leveraged trading. If you look to what Hargreave Lansdowne has achieved, I believe there is good future ahead for IG, expecialy in the leveraged market where their expertize lie. I am actually thinking to open an account myself as the platform I use at this moment cannot cope very very m well with International shares.
The problems other firms had with Swiss Franc etc just show that you need to chose a very well capitalised firm which is a leader in the field.
Walbrock Research (@Wh_biz32) says
Just a couple of questions.
One, if the EU does tighten financial regulations, how much of IG’s revenue is from Mainland Europe vs. the UK.
Two, I noticed the EPS growth rate is slowing (at an average of 4% per year in the past 5 years, or cumulative growth of 19%) despite the latest pick up in 2016. With the shares more than doubled.during the same period and 600% from its 2009’s lows, does IG still represent a good investment when the world economy is awash with more debt than it could handle?
John Kingham says
Hi, thanks and to your to points:
1. According to SharePad, Europe makes up 16% of profits compared to 55% for the UK, so Europe is significant but not critical (IMO).
2. Growth had slowed down over the last few years which is why I was able to pick up the shares at a seriously low price and with a 4.6% dividend yield. However, despite the rapid share price gains I do still think this company represents good value for money, although of course I could be wrong. As always, only time will tell.
Finally regarding debt, I’m not sure what global debt levels have to do with IG, other than systemic issues which could potentially impact all companies in a variety of uncertain ways? More specifically, I don’t see IG as being particularly exposed to either personal or corporate debt problems.
It’s cheap now John.
John Kingham says
Wow, a 40% decline in one day. That’s one of the biggest one-day drops I’ve seen in one of my holdings.
Will be interesting to see how much impact the FCA’s regulatory changes to the CFD market actually make. Also, whether this was the stock market in blind panic mode or a well thought through revaluation of IG’s future cash flows (I’m guessing the former, but you never know).
John, Not ever having been that close to this sector, I could be wrong, but everything I have rather speed read today leads me to believe that whilst sentiment is hugely negative toward the sector, IG’s client base is generally less inclined to max out on leverage. The whole concept of CFD-Spread betting is not of course pour moi, but then again I don’t smoke, yet I do buy tobacco stocks.
Each to their own I guess. I dipped my toe in today with just 0.5% of my wad. I will read all the recent reports, look at the regulations and if I’m happy with what I read, I’ll probably lift this to as much as 2%.
In fact it’s so cheap — I just bought some