The Key to Nasdaq's Success and Growth: Volume, Volume, and Volume

| About: Nasdaq Inc. (NDAQ)

It’s been tough to jump into this market. Nearly every day, the pundits seem to change course on whether we’ve already hit bottom or are only at the tip of the recessionary iceberg. At SmartGuyStocks, we have decided to generally sit on the sidelines for now with our favorite long-term plays and wait for things to shake out a bit before taking any new positions.

So while we’re waiting to jump back in, I wanted to take this opportunity to catch up with one of our favorite companies, Nasdaq Stock Market (NASDAQ:NDAQ). Despite a market slump, the stock is up nearly 30% from where we recommended it in July, and we believe it will continue to be a winner for years to come.

Last week, Nasdaq followed the huge swings of the market, temporarily nose-diving on fears of a recession. Ironically, Nasdaq is minting cash out of those fears in the form of transaction fees from record share volume. Last week, Nasdaq CEO Bob Greifield announced “At the moment, our business is doing better than it ever has because the volumes have been incredibly high.. So, it’s (the recent period of high volatility) been very good for us.”

And don’t be distracted by the hubub over the potential reduction in IPOs that has caused some to worry; initial listing fees accounted for less than 1.5% of Nasdaq’s record 1.7B in 2006 revenue. The success and growth of Nasdaq comes down to three simple words: volume, volume, and volume.

And the long-term growth of trading volume is one trend that we can count on. The World Federation of Exchanges has some great data showing the incredible growth of exchanges since 1990. Just for illustration, the value of shares traded on the Lima Stock Exchange (Peru) has increased 55-fold, while the Tokyo Stock Exchange has increased 600% despite a lackluster economy. Even oou own mature financial market grew overall volume by 25% in 2007 alone. And if that’s not enough to juice growth, new exchanges in emerging markets like Vietnam, Colombia, and even some African countries are beginning to take hold.

The opportunity for the largest exchanges like Nasdaq and NYSE Euronext to consolidate this fast-growing and fragmented space is obvious. Economies of scale are especially valuable in the exchange business, where trading is done by computer networks that require large fixed costs. Consolidation can lower trading costs, which attract more traders and listing companies. Larger exchanges also create increased liquidity, helping share prices move more quickly and efficiently.

As expected, we are seeing a lot of acquisitions, with NYSE buying Euronext and AMEX, and Nasdaq buying OMX (Nordic exchanges) and the Philadelphia and Boston exchanges. It looks like we are indeed moving towards the vision presented last year in The Wall Street Journal: “The accounting world has the Big Four. The auto sector had the Big Three. And stock exchanges, once a fragmented industry with dozens of players, may be headed toward a Big Five or Six.” Nasdaq has announced that it will spend 2008 integrating its three acquisitions, but will again be on the prowl for new buys in 2009.

Nasdaq’s recent deal with Borse Dubai perhaps foreshadows things to come. As part the OMX acquisition, Nasdaq and Borse Dubai traded stakes in their respective companies. The Dubai Exchange will be re-branded as the “Nasdaq DIFX” and will leverage Nasdaq’s software platform for expansion. It’s a promising development that the world’s next great financial center places immense value on Nasdaq’s platform, brand, and expertise. As the global economy continues to grow, more emerging markets will no doubt see value in partnering with the market leader.

Not only is the size of the pie growing, but Nasdaq appears to also be doing a good job taking a bigger slice from competitors. Last year, Nasdaq became the largest U.S. exchange, processing 29% of all equity trades in December, up from 27% in 2006.

Nasdaq reports earnings before the market opens this Thursday. I would use any negative market reaction or near-term weakness to pick up more shares, as this is a long-term story that is just starting to play out…

Disclosure: SmartGuyStocks is long NDAQ