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Published: September 22, 2009
It's amazing what a simple metric can tell you
about a company.
Especially an unflappably accurate metric. This yardstick cuts
to the chase and tells you exactly how well a company performs.
It's in every company's SEC filings.
It's on nearly every financial website.
Most investors skip right over it.
I'm talking about operating margins. It tells you how much a
company makes on each dollar it brings in -- before accounting
for taxes and interest. The higher the number is, the better.
The only caveat? Consistency. When you look at operating
margins, the hallmark of a good stock pick is a consistent or
steadily climbing operating margin.
Consider Moody's Investor Service (NYSE: MCO). The company is
one of only three players in the credit-ratings business. For
years, Moody's had what Warren Buffett refers to as a wide moat
-- a sustainable competitive advantage that protects the
company's ability to generate profits. But that moat has
sprung a leak because of criticism that it couldn't
objectively rate securities leading up to the subprime meltdown.
This has filtered down to the bottom line at Moody's. Operating
margins have declined -25% during the past two years.
One company that has kept its margins steady is CME Group (Nasdaq:
CME) -- the most profitable company in the S&P with an operating
margin of 62%. It also has a near-monopoly in a market that is
growing at a scorching pace.
CME Group runs three of the largest futures exchanges in the
world: The Chicago Mercantile Exchange -- where the "CME" in its
name comes from -- and the New York Mercantile Exchange (the
NYMEX) and the Chicago Board of Trade. These marketplaces are
where commodities, stock-index futures and major currencies
trade.
CME charges a fee for every trade on its exchanges. The more
volume these exchanges have, the more fees CME collects. Traders
flock to highly liquid exchanges because they offer favorable
prices, which gives the company a distinctive advantage. This
barrier to entry -- an effective corner on U.S. commodity and
currency trading -- is why CME has only one major competitor in
the U.S.
Here's another nifty facet of
CME's business model: It makes money
twice on most of the securities it
offers. Many of CME's contracts
can't be transferred. That means you
can't buy futures on one exchange
and sell them on another. There are
a million other investors to trade
with, but there's only one place to
execute the buy and sell orders.
By now you may have heard that the
Commodities Futures Trading
Commission wants to
regulate some commodity and
derivative trading. Regulators are
worried that speculation has caused
higher energy prices. A lack of
transparency in the way derivatives
are handled has also caused some
grief. (Just ask AIG.)
The CFTC wants to limit some
trading. Worries that this may
affect liquidity on exchanges have
weighed on CME's shares. But trading
demand for oil, agricultural
commodities and metals has soared in
recent years, and it's unlikely to
let up any time soon.
CME is also aggressively seeking
expansion in foreign markets. The
company recently announced that it
entered talks with Bolsa Mexicana de
Valores, the second-largest exchange
in Latin America, to acquire a
minority stake in the Mexder
derivatives exchange. Don't be
surprised if CME makes additional
deals like this in the future. The
more volume, the more fees it
collects.
Investors should take notice any
time Uncle Sam gets involved in Wall
Street. But in this case, those
fears have CME shares trading for
just 20 times earnings. That's about
the S&P average right now, but it's
cheap for these shares, which have
traded for 35 times earnings during
the past five years. (The shares
need to climb +75% to reach that
level.)
A buying opportunity like CME is
rarely seen for a company that makes
62 cents for every dollar it brings
in. August trading volumes were up
+5% from July to 10.2 million
contracts a day and will continue to
rise once a full recovery takes
place.
--
Brad Briggs
Staff Writer
StreetAuthority |
