The Zacks Investment Bank industry is supported by market volatility-driven growth in the trading business, which is expected to continue as the uncertainty-induced volatility will likely persist in the near-to-medium term. While costs related to technological upgrades might impede bottom-line growth, these will eventually lead to improved operating efficiency.
Yet, a challenging operating backdrop has resulted in faltering industry-wide corporate debt and equity issuances and muted global deal-making activities. Despite these headwinds, a few names, like Interactive Brokers Group, Inc. (IBKR – Free Report) and LPL Financial Holdings Inc. (LPLA – Free Report) , are worth betting on.
The Zacks Investment Bank industry consists of firms that provide financial products and services that include advisory-based financial transactions to corporations, governments and financial institutions across the globe. These started as partnership firms focused on initial public offerings (IPOs), secondary market offerings, brokerage and mergers and acquisitions (M&As). Gradually the companies have evolved into providers of various other services, including securities research, proprietary trading and investment management. Therefore, the industry players work mainly through three product segments — investment banking (comprising M&As, advisory services and securities underwriting), asset management and trading and principal investments (consisting of proprietary and brokerage trading).
3 Major Trends Shaping the Future of the Investment Bank Industry
Trading Business to Offer Support: Client activity in the trading business largely depends on the prevalent macroeconomic and geopolitical conditions. Since the beginning of 2022, market volatility has significantly increased on several geopolitical and macroeconomic concerns. Before that, the investment banking industry had witnessed a similar level of volatility from March 2020 till the first couple of months of 2021 owing to the coronavirus outbreak-induced uncertainty. The current prevalent situation is likely to persist in 2023 as the markets are still grappling with looming recession expectations, the COVID-19 breakout in China and other geopolitical matters. Hence, the trading volumes will continue to rise, driven by huge client activities in both equity and fixed-income businesses, thereby boosting trading income.
Technological Upgrades to Improve Operating Efficiency: Innovative trading platforms and investments in technology and advertising are likely to support the overall operations of investment banks. The industry players are emphasizing attracting and retaining the best talent for building a leadership team and spending on technology to support clients with infrastructure development and new platforms. While investment banks are likely to face increasing technology-related costs in the near term, these initiatives are expected to result in improved operating efficiency over time.
Slowdown in Underwriting and M&As: After a blockbuster performance in 2021, IPO, underwriting and deal-making activities have almost come to a grinding halt since the start of 2022. The primary reasons for the shrinking investment banking (IB) activities are the ongoing Ukraine-Russia conflict, global supply-chain disruptions significant monetary policy tightening across the globe to control raging inflation and recession risks. These tough market conditions are leading to a plunge in stock prices and slowing global economic growth, thereby hurting debt and equity issuances. While the deal pipeline looks healthy, there has been a substantial decline in M&A activity and volumes. Thus, subdued underwriting and advisory businesses are expected to keep hurting industry players’ revenue growth in 2023.
Zacks Industry Rank Indicates a Bright Picture
The Zacks Investment Bank industry is a 17-stock group within the broader Zacks Finance sector. The industry currently carries a Zacks Industry Rank #42, which places it in the top 17% of more than 245 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates rosy near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.
Before we present a few stocks that you may want to consider on the back of an improving trading picture, let’s take a look at the industry’s recent stock market performance and valuation picture.
Industry Outperforms Sector and S&P 500
The Zacks Investment Bank industry has outperformed its sector and the S&P 500 over the past two years. While the stocks in the industry have collectively gained 22.5%, the S&P 500 composite has rallied 1.1% and the Zacks Finance sector has risen 5.6%.
Two-Year Price Performance
One might get a good sense of the industry’s relative valuation by looking at its price-to-tangible book ratio (P/TBV), which is commonly used for valuing investment banks because of large variations in their earnings results from one quarter to the next.
The industry currently has a trailing 12-month P/TBV of 3.81X, above the median level of 2.66X, over the past five years. This compares with the highest level of 4.09X and the lowest level of 1.37X over this period. However, the industry is trading at a huge discount when compared with the market at large, as the trailing 12-month P/TBV ratio for the S&P 500 is 9.76X and the median level is 9.85X.
Price-to-Tangible Book Ratio (TTM)
As finance stocks typically have a lower P/TBV ratio, comparing investment banks with the S&P 500 may not make sense to many investors. But a comparison of the group’s P/TBV ratio with that of the broader sector ensures that the group is trading at a decent discount. The Zacks Finance sector’s trailing 12-month P/TBV ratio of 4.54X and the median level of 3.90X for the same period are above the Zacks Investment Bank industry’s respective ratios.
Price-to-Tangible Book Ratio (TTM)
2 Investment Banks to Buy for 2023
Interactive Brokers: This Zacks Rank #2 (Buy) company operates as an automated global electronic market maker and broker. The company, based in Greenwich, CT, specializes in routing orders, executing and processing trades in securities, futures, foreign exchange instruments, bonds and mutual funds on more than 135 electronic exchanges and market centers worldwide.
Since its inception, Interactive Brokers has been chiefly focusing on developing proprietary software to automate broker-dealer functions, which has resulted in steady top-line improvement. Also, innovative products and the launch of several new products and services (like IBKR GlobalTrader and IBKR Lite) are expected to strengthen the company’s position in the online brokerage space. The company has also launched cryptocurrency trading via Paxos Trust Company, charging lower commissions than other crypto exchanges.
Though rising expenses act as a deterrent, the company continues to explore opportunities in the emerging markets of Taiwan, Mexico and India. Given the rapid growth of its European business, IBKR has substantially expanded its operations there. These diversification efforts help it experience revenue stability.
Shares of the company, which has a market cap of $30.6 billion, have lost 9.2% over the past year. The Zacks Consensus Estimate for earnings implies year-over-year growth of 16.9% and 27.8 % for 2022 and 2023, respectively.
Price and Consensus: IBKR
LPL Financial: This Zacks Rank #2 company is a clearing broker-dealer and an investment advisory firm. The company, based in Boston, MA, acts as an agent for its advisors on behalf of its clients by providing access to a broad array of financial products and services.
LPLA has been making efforts to increase its client base. Given the company’s recruiting efforts and solid advisor productivity, advisory revenues are expected to keep improving. The acquisition of Allen & Company in 2019 and the launch of a no-transaction-fee exchange-traded fund network will continue to boost the value of LPL Financial’s advisory platform.
LPL Financial has accomplished several strategic deals over the past few years. In July 2022, it entered into an agreement to acquire the private client group business of Boenning & Scattergood, while in 2021, it acquired Waddell & Reed’s wealth management business. These, along with the past inorganic expansion efforts, will continue to support growth and help LPL Financial diversify revenues.
LPLA has a market cap of $17 billion. Over the past 12 months, shares of the company have jumped 31.6%. The Zacks Consensus Estimate for earnings indicates year-over-year surge of 61.3% and 72.8 % for 2022 and 2023, respectively.
Price and Consensus: LPLA