Things are looking up. In the US at least the stockmarkets look to have resumed uptrends following February’s short correction. The general mood has calmed down from the euphoric state we were in in January. My portfolio has had a good week and is back near its highs. All of this I think bodes well for returns in the near future at least…
I made a few trades this week. I sold out of three holdings: Trigano, Trex and Cranswick. All three have recently issued fairly positive trading updates, but the share prices were starting to languish so it seemed like a good idea to swap them for other candidates with better momentum. I bought two new holdings: Euronext and Broadridge Financial Solutions. Both of these follow a financial services theme, though this is incidental rather than deliberate.
Euronext is listed on the Paris stock exchange. It owns various stock exchanges across Europe, including Paris, Amsterdam, Lisbon, London and recently Dublin. It was originally part of the NYSE Group until being spun off a few years ago (the rationale being to simply the governance of NYSE by avoiding multiple regulatory regimes). I’ve been getting interested in stock exchanges as investments recently, due to their excellent economics and strong competitive advantages. It also seems to be a sector undergoing some consolidation and it seems possible that Euronext would make a good takeover candidate at some point. After an abortive attempt investing in CBOE, I’m ready for another go.
- Business economics: Euronext is a highly profitable business. Like other platform businesses it generates revenue from transaction fees but has a largely fixed cost structure. This leads to benefits from operational gearing – when transaction volumes increase revenues rise but costs rise to a much lesser extent. This creates a disproportionate impact on profits. Euronext has very large profit margins (50% operating profit margin) and excellent returns on capital (between 30-50% for the last few years).
- Track record: Euronext has a relatively short record as an independently listed business. Prior to that its profits suffered a bit of a setback in the EU sovereign debt crisis in 2012. Apart from that, the track record is decent with Euronext generating decent growth in profits over the past few years.
- Competitive advantage: Euronext, and stock exchanges in general, appear to have very strong competitive advantages. There is some competition in that businesses or other asset owners can choose which exchange to list on, and traders can choose which exchange to trade on (to the extent that investments are listed on multiple exchanges). This competition does create some incentive to ensure trading costs are not too high and technology is up to date. However, this competition is limited as stock exchanges are largely organised into regional monopolies. Powerful network effects mean that it is very difficult for a new entrant to set up a stock exchange to compete with one of these regional monopolies.
- Growth prospects: opportunities to grow into different regions or capture market share from other exchanges are somewhat limited and rely to a large extent on acquisition. However, the overall demand for stock exchange services is experiencing long term secular growth, both from increasing transaction volumes and from demand for newer derivative products.
Momentum is excellent, with Euronext recently issuing positive results and a positive outlook and the share price breaking out to new highs. The valuation seems very reasonable to me, given the quality of the business.
Broadridge Financial Services
Broadridge is a fintech company that provides various ICT services predominately to the financial services industry, including trade execution and accounting, communications platforms and data analytics.
- Business economics: Broadridge is a knowledge-based capital light IT business and is highly profitable. It has decent operating margins and consistently generates returns on capital of above 20%.
- Track record: since listing in 2007, Broadridge has an excellent track record of rapid and very consistent growth in revenues and profits. Correspondingly since the financial crisis the share price has risen very steadily
- Competitive advantage: Broadridge appears likely to benefit from sticky customers – the costs of switching provider for the kind of services Broadridge provides seem likely to be very high and so switching only likely to occur if an alternative is clearly superior. The competition it faces seems likely to be more dynamic in nature i.e. from competitors with new better technology. Broadridge also looks to be a market leader in its field and at the forefront of technology in the products and services its provides.
- Growth prospects: the market seems likely to benefit from secular growth and there are opportunities to grow through improvements in technology and expansion into new geographic areas.
Momentum is excellent, with recent positive results and the share price at new highs. The valuation seems reasonable given the quality of the business and growth prospects.