Many investors don’t realize you can actually buy stock in the Nasdaq Stock Exchange through publicly traded Nasdaq Inc. (NDAQ, Financial). Revenues from various exchanges produce less than half of this company's total income; the rest comes from other business lines, including listing services, analytics and various market technology applications.
Nasdaq created the world’s first electronic stock market back in 1971 and its technology powers more than 70 marketplaces in 50 countries. The Nasdaq Exchange is home to over 3,500 listed companies with a cumulative market value of over $9 trillion. The company currently has a market capitalization of $25 billion and generated $5.9 billion in revenues in 2021.
However, while we have the opportunity to invest in Nasdaq, the real question is, would that even be a good idea? The stock has good historical growth, but can it keep it up in the coming years? Let's take a look.
Business overview
Nasdaq's business is composed of four main segments: Market Services, Corporate Platforms, Investment Intellligence and Market Technology.
Market Services includes equity and derivatives trading, clearing, trade management and fixed income services. This segment houses the global exchanges, including the Nasdaq exchange in the U.S. This segment represents about 36% of total revenues.
Corporate Platforms includes exchange listing services, investor relations intelligence, ESG advisory practices and other C-suite related offerings. This segment represents roughly 18% of total revenues.
Investment Intelligence involves market data, index and analytics related businesses. Nasdaq sells and distributes historical and real-time market data to a variety of trading and investment firms. This segment represents roughly 32% of total revenues.
Market Technology products and services involve marketplace infrastructure technologies for exchanges on a global basis as well as anti-financial crime technology services. The company offers a SaaS solution to help brokers and investment firms comply with market rules, regulations and trade surveillance. This segment represents approximately 13% of total revenues.
Verfin acquisition
In February 2021, the company completed its acquisition of Verfin for $2.75 billion in cash. Verfin is an industry leader in financial crime management products, providing a cloud-based software platform for fraud detection, anti-money laundering compliance, high risk customer management and information sharing. Customers include over 2,000 banks and credit unions.
This acquisition is expected to drive strong double-digit growth over a three to five-year time period within the company’s Market Technology segment.
Financial review
The company has been putting up some strong organic growth numbers in this historic global bull market because of the global free flow of capital. Organic revenue growth was 14% in 2021 and net income increased 27% for the year.
The company has historically generated strong levels of free cash flow, hitting the $1.0 billion mark in full fiscal 2021. The company is investment grade rated and has a leverage ratio of approximately 3.1.
However, the times are a-changing, as Bob Dylan once sang. First quarter revenues for the company's fiscal 2022 only grew 6.0%, largely due to a 6.0% decline in the Market Services segment, which included a 20% decline in cash equity trading and a 19% decline in fixed income related services. Listing services remain relatively strong, but for how long? The SPAC boom is almost over and the IPO market will almost certainly slow down as the stock market enters its inevitable bear market phase.
Valuation
Despite a 30% retreat from 52-week highs, Nasdaq's stock still sells at elevated levels that may not be taking into account future market risks. Yes, the exchange related trading services only account for 36% of the total company, but many of the other segments are also dependent on strength in the capital markets as well as strength in the banking industry and other investment related operations.
GAAP earnings per share estimates from Wall Street call for 2022 earnings per share of approximately $7.20, which would create a forward price-earnings ratio of over 20. Analysts expect modest EPS growth of 8% to 9% for 2023, but that won’t happen in a severe market downturn, a recession, or if the capital markets dry up.
The company has a history of regular dividend increases and currently pays an annualized dividend of $2.40 per share, which equates to a dividend yield of 1.58%, roughly in line with the current S&P 500 dividend yield.
The company has no tangible shareholder equity, which is currently -$5.0 billion due to large amounts of goodwill on the balance sheet from previous acquisitions.
Guru trades
Gurus who have purchased Nasdaq stock recently include Murray Stahl (Trades, Portfolio) and Jeremy Grantham (Trades, Portfolio). Gurus who have reduced or sold out of their positions include Ken Fisher (Trades, Portfolio) and Lee Ainslie (Trades, Portfolio).
Conclusion
Nasdaq has done a great job diversifying the company away from dependance on trading and exchange related revenues. However, most of the business is still tied to the capital markets as well as the investment and banking industries. Due to the inherent cyclical nature of those industries, a growth multiple may not be appropriate for Nasdaq at this point. Patience may be needed at this point before the company becomes undervalued.
