Here's the complete Seeking Alpha article on $VIRT (minus the pictures of charts etc..)that Congo Mining posted the link to in a couple of posts before this one.
Virtu Financial - A High Frequency Trading Company With A Clear Edge
Apr. 20, 2015 11:13 AM ET | 18 comments | About: Virtu Financial, Inc. (VIRT)
Disclosure: The author is long VIRT. (More...)
Summary
•Virtu is the only game in town when it come to High Frequency Trading - scarcity will be the tailwind for the stock price.
•The company's track record speaks of consistent growth and stability - trading income is up over 40% since 2011.
•Virtu's profits depend on the market volumes, meaning it will fare well in turbulent markets.
High Frequency Trading has been in the public eye since at least the Flash Crash of 2010 and the "Flash Boys" demonized the whole industry. One could argue that the HFT has made the markets more volatile and vulnarable as more and more volume is crammed into decreasing time frames. On the other hand, one could argue that the HFT industry provides a vital service of providing liquidity and thus bringing down spreads and overall costs for the other market participants.
Overview
Various estimates place HFT volumes somewhere between 50% and 80% of the total, depending on the market - lower in the Foreign Exchange and higher in the Futures and Equities.
Virtu Financial (NASDAQ:VIRT) made waves in the investment community with the revelation of its more than 1000-day long winning streak, having only one losing day over a 1238-day period in 2011 to 2013. What's more, even that was deemed to be statistically near impossible according to a mathematical study conducted by Greg Laughlin, a professor of astrophysics at the University of Santa Cruz.
Laughlin, in his calculations, relies on the fact that Virtu is profitable in 51%-52% of all trades according to Dough Cifu, the CEO of Virtu Financial. In addition, Laughlin estimated that during the observed period, Virtu made around 800,000 US Equity trades per day. Below is an excerpt from Laughlin's paper, which is a must read, where the odds of daily and weekly profitability are summed up neatly.
At Virtu's rate of equity trading, the model (taken at face value) indicates an effectively zero chance of having an unprofitable full day of trading. We can therefore conclude that Virtu's single reported losing day (out of Nd = 1,278 trading days from 2011-2014) resulted from either a technological or human-caused error.
Laughlign then goes on to point out a correlation between Virtu's past profitability and the market volumes. And as one would expect due to the nature of market making, the higher volume of the stock market is highly correlated with the company's returns.
The x-axis simultaneously represents the SPY volumes (100M shares) and Virtu's profit (Million/day). The conclusion to draw here is that the company thrives in the high volume environments - think earning seasons, unexpected news, turbulent markets.
In addition, the latest trends suggest that Virtu is aggressively moving into the FX market, reporting an increase from 14% in 2012 to 20% in 2013 in the prospectus - a market with 12% CAGR from 2004 to 2013 and daily volume of around $5.3 trillion. All this indicates an immense growth potential.
Unfortunately, the prospectus does not specify the margins for different markets, but we can assume they are in the same order of magnitude, because the FX segment growth from 2012 to 2013, left the operating margin stable at 52%.
Valuation
The company is up over 20% since the IPO, currently trading at $22.66 or 12.7x TTM P/E. Now, in my own opinion, the price has not shot sky high, because the markets remain uncertain on the fair value of the company due to its novelty in the investment landscape. It is hard to say what the fair P/E multiple for the company is because there are no other publicly-traded HFT firms out there for comparison. Yet, when considering the stability of the operating income and the future growth prospects in the high volume markets, the current stock price seems to offer a great entry point. Especially when considering that the company has managed to grow its trading income (up over 40% from 2011 to 2013) while the exchange volumes have been consistently trending down year over year, largely due to dark pools.
Source: TABB Group, MarketWatch
The risks
The Flash Crash of 2010 was a reality check for the market participants. Since then HFT has been associated with instability and is often identified as the cause of odd market moves that defy rationality.
The potential regulatory backlash remains the threat number one for Virtu's future. My personal opinion is that we first need to see a market event in at least the same magnitude as the Flash Crash of 2010 to see any regulatory push to curb the industry and even then it will take a lot of research on the part of the regulatory establishments to get to the roots of the problem and then design effective countermeasures, largely due to the ever more sophisticated algorithms devised by the brightest heads in the industry.
The takeaway
The takeaway here is that although the HFT may face regulatory hurdles in the future, it will take a huge event to get SEC on its feet. So far the evidence indicates that the HFT can exacerbate a selloff by drawing liquidity when it is the most needed, but so does every other market participant when an unexpected event drives them to chase the offer price in a panic.
Virtu is trading at extremely low valuation multiples based on its growth track record and the clear edge it possesses in its market making activities, leaving a lot of room for a multiple expansion in addition to the bottom line growth.
At this point in time, Virtu is the only available play to take a long position in the HFT industry and thus has the potential to be an extremely sought after company when investors have had some time to dig deeper into the algorithmic trading world.
I have not been so excited about a company in a long time and Virtu is definitely in the long camp. There, of course, is the chance that I might have missed some critical points in this article, so please comment below on what you think of Virtu's future growth potential and the HFT industry at large."
END OF ARTICLE
DD22
Stock Trading...ha ha...Child's Play.
