Note: All data are as of the close of Wednesday, November 5, 2014. Emphasis is on company fundamentals and financial data rather than commentary.
Who do you think made the most money from the gold rushes in California in the mid-1800s and the Yukon in the late-1800s? It wasn't the prospectors, that's for certain, as many of them ended up losing their entire life savings as they migrated from other parts of the country, never to find enough gold to even earn a living.
So who did make all the money? The business owners who catered to the prospectors' needs - like hotels, restaurants, barbers, clothiers, supplies merchants and, of course, the saloons.
Let's now extend this analogy to the stock market and ask who you think makes more money there? By the same principle, it is most often the companies that cater to the traders' and investors' trading needs, such as the brokers, exchanges and clearing houses. Thanks to their commissions and fees, they make money even when traders lose.
This can be clearly seen during the economic crisis of a few years back, as noted in the graph below, which spans June 2007 to the market's bottom in early March 2009. Where the broader market S&P 500 index [black] fell 55% and the SPDR Financial Sector ETF (NYSE: XLF) lost 84%, the two largest U.S. Diversified Investments companies - Intercontinental Exchange, Inc. (NYSE: ICE) [beige], and the Nasdaq OMX Group, Inc. (NASDAQ: NDAQ) [purple] - lost 56% and 40%, respectively.
Afterward, these exchange services providers continued to book profits, beating the broader market all the more as the economy recovered, as noted in the graph below.
Since the last major correction bottomed at the end of September 2011, where the S&P index has gained 85%, ICE is up 86%, NDAQ is up 96%, and the third largest U.S. company in the space - CBOE Holdings, Inc. (NASDAQ: CBOE) [orange] which debuted as a public company in July of 2010 - has risen 157%.
On an annualized basis since that 2011 correction, where the S&P index has averaged 27.57%, ICE has averaged 27.89%, NDAQ has averaged 31.14%, and CBOE has averaged 50.92% per year.
What do these three Diversified Investments companies do that allows them to beat the broader market like that? They operate networks of regulated exchanges and clearing houses in the U.S., Canada, U.K., Europe and Asia, facilitating the trading and clearing of equities (stocks and ETFs), equity derivatives (options and futures), bonds, interest rates, currencies, commodities and commodity derivatives by providing trade execution, listing services, price discovery, trade processing, clearing, settlement and post-trade processing, central depository services, and market data services.
Though the companies take only a very tiny percentage in commissions and fees, with more than 1.3 trillion shares traded on just U.S. stock exchanges this year so far, well on its way to matching last year's 1.5 trillion shares as tabulated by BATS Global Markets, all those little tiny pieces of the pie add up to a whole lot of dough.
Over the trailing 12 months, ICE, NDAQ and CBOE reported revenues of $2.5 billion, $3.43 billion and $590 million respectively, representing 10%, 46.54% and 11.40% of their respective market caps. And the good times look set to continue, as tabled below where green indicates outperformance while yellow denotes underperformance.
While the Diversified Investments industry's earnings growth is seen outperforming the broader market's S&P average earnings growth in the current quarter, next quarter looks to deliver earnings shrinkage.
But improvement is to follow once again, with growth only slightly underperforming the market in 2015, on its way to outperforming by 23.3% greater growth over the next five years.
Zooming in a little closer, the three largest U.S. companies in the industry are seen underperforming the broader market's earnings growth only in the current and next quarters, as tabled below.
Then all three are expected to outgrow the market's earnings in 2015 and beyond, with varied growth rates ranging all the way up to as high as 2.3 times the market's growth rate.
But there is more than earnings growth to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?
Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.
A) Financial Comparisons
• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.
• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.
In the most recently reported quarter, ICE posted the greatest revenue and earnings growth year-over-year by a substantial degree, while NDAQ delivered the least.
• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.
Of our three contestants, CBOE operated with the widest profit margin where ICE had the widest operating margins. Meanwhile, NDAQ contended with the narrowest margins in both.
• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.
In returns on assets and equity, CBOE's management team returned the most on both by a substantial degree, while ICE's team returned the least on both.
• Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
Of the three companies here compared, NDAQ provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price, while ICE's DEPS over stock price was the lowest.
• Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value come under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.
Among our three combatants, NDAQ has the cheapest stock relative to forward earnings, company book value and 5-year PEG, while CBOE's stock is the most overpriced in each.
B) Estimates and Analyst Recommendations
Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.
• Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.
Of our three specimens, NDAQ offer the highest earnings percentages over its current stock price in all time periods, while ICE offers the lowest percentage for the current month's earnings, and CBOE has the lowest for the remaining time periods.
• Earnings Growth: For long-term investors this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.
For earnings growth, CBOE and ICE are projected to deliver the greatest growth in the near quarters, with ICE continuing to deliver it in 2015 and beyond. At the low growth end of the spectrum, NDAQ is projected to deliver the slowest growth rate throughout, with a couple of ties with CBOE.
• Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.
For their high, mean and low price targets over the coming 12 months, analysts believe ICE's stock has the greatest upside potential and least downside risk, while CBOE's stock is believed to have least upside potential and greatest downside risk.
• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up are analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.
Of our three contenders, ICE is best recommended with 4 strong buys and 11 buys representing a combined 88.24% of its 17 analysts, followed by NDAQ with 3 strong buy and 7 buy recommendations representing 66.67% of its 15 analysts, and lastly by CBOE with 1 strong buy and 4 buy ratings representing 31.25% of its 16 analysts.
Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.
In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.
The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.
And the winner is… ICE by just a few ticks, outperforming in 13 metrics and underperforming in 9 for a net score of +4, followed not far behind by NDAQ, outperforming in 11 metrics and underperforming in 10 for a net score of +1, and finally by CBOE way in the distance, outperforming in 8 metrics and underperforming in 14 for a net score of -6.
Where the Diversified Investments industry is expected to improve from underperforming the S&P broader market substantially next quarter, to underperforming modestly in 2015, to outperforming modestly beyond, the three largest U.S. companies in the space are expected to deliver improvements of their own, underperforming over the near term, while outgrowing the market's average earnings in 2015 and beyond.
Yet after taking all company fundamentals into account, ICE stands first among its peers given its highest cash over market cap, highest trailing revenue and earnings growth, widest operating margin, highest EBITDA over market cap, highest future earnings growth overall, highest analyst price targets, and most analyst strong buy and buy recommendations - handily winning the Diversified Investments industry competition.