Back to the races

January seems to have got off to a flying start with stock markets resuming their bull run. I’m currently basking in the warm glow from a rash of positive trading updates issued by several of my larger holdings, including Boohoo, Games Workshop, Gamma Communications, Liontrust and most notably Best of the Best (notwithstanding rather perverse reactions from Boohoo and Games Workshop). Nice as this is, it’s hard to ignore the current speculation that we are in a bubble and that impending doom is lurking somewhere round the corner. It does feel that way. After discussing this in my last few posts, I don’t have much new to say about the bubble. I set out my plan of action in my January review.

A point I made in my January review was that the one scenario in which I would consider changing my approach (at least temporarily) would be if it became clear that inflation and interest rate expectations had changed. I thought this would be some way off. Naturally, since then my newsfeed and social media seem to have been flooded with speculation about imminent inflation given that US Treasury yields are already rising. Nothing overly dramatic has happened so far, but it is another warning light starting to blink. That said, I am having second thoughts about whether trying to anticipate inflation and interest rates is something I should really be thinking about. As for every other macro variable, it seems very hard to anticipate the timing of the market’s likely response. My broader thinking is that, while we will get a cyclical rise at some point, interest rates are most likely set to remain relatively low in the longer term. I’m now thinking that trying to time the market on this is not something I should really be worrying about unless I have some more compelling insights.

I have two recent trades to update on. One from back in December. I was a forced seller of Match, taking a 50% profit. I replaced it with CMC Markets. For my January trade I have sold ServiceNow and replaced it with Canada Goose. I bought Canada Goose fairly recently and wrote about it here, so won’t do so again. In hindsight I think I was too quick to get cold feet and sell Canada Goose previously – not something I think I would have done had I only been making one trade a month. The rationale for my current trade is mostly based on relative valuations. As much as I like ServiceNow as a business, I’m still trying to limit my exposure to highly valued shares at the moment. In the end I decided to sell ServiceNow rather than Pinterest, which had been top of my list.

CMC Markets

CMC Markets is primarily a retail spread betting business, much like IG Group, which I also hold. It is well geographically diversified across the UK, Europe, Australia and a handful of other countries. While most of its revenues come from spread betting and CFDs, it has been diversifying into other services, such as stock broking. Over the past few years spread betting companies have had to contend with tightening regulation on what can be provided to retail customers in many jurisdictions. This hump has pretty much been cleared now.

One of the attractive characteristics of this sort of business that I have mentioned a few times previously is that it benefits from high volumes of trading activity, which in turn is a function of high volatility. Holding an investment that benefits from volatility seems like a good idea at the moment. It should do well either if the market crashes or if it shoots up in a dramatic bubble, provided volumes are high (which is likely in either scenario). It also provides a hedge of sorts to most of my other investments which tend to benefit from lower volatility.

Quality

  • Business economics: the economics for this sort of capital-light business are excellent. CMC is highly profitable and can scale relatively cheaply. Margins and returns on capital are consistently very high.
  • Track record: CMC markets was founded just over 30 years ago in 1989 and is still run by the founder Peter Cruddas. Since then it has rapidly expanded to offering various online services in multiple geographies before floating in 2016. Over the past few years CMC has had a decent record of growth, though this has been a fairly difficult period with some major regulatory changes and low volatility. Overall, I’d say its track record seems pretty decent all things considered.
  • Competitive advantage: I’d say this was the weak point. CMC likely has some competitive advantage and seems to be enjoying some success in increasing its market share. However, it’s not the sort of market where you can be very confident in this persisting indefinitely. The retail financial services provided by CMC seem fairly commoditised and competitive. There is likely to be some customer ‘stickiness’ derived from the inconvenience in switching, but not a great deal. It is not actually very difficult for customers to multi-home or switch provider if they put their mind to it. This is likely to result in a degree of pricing power but contingent on the provider delivering a consistently high quality service – reliability is critical. CMC seems to score pretty highly here – its robust infrastructure dealt very well with the increased volumes this year while some competitors, including IG Group, struggled.
  • Growth prospects: long term growth prospects seem decent there seems to be plenty of scope for CMC to continue to grow. The overall market is growing, CMC’s market share is growing and most importantly there are plenty of new geographies for CMC to enter. In the short term, CMC is on a very positive trajectory, though this is partly due to the one-off benefit from the huge increase in volatility this year.

Price

Momentum is very strong. Naturally, CMC has been repeatedly exceeding expectations through the pandemic. The valuation superficially looks very cheap but this is to some extent because trading is expected to slow down soon as the pandemic boost wears off. My view is that boost is quite likely to be more sustained than currently anticipated and that the business looks good value given its quality even accounting for a return to normality.

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