June 2008 Stock Pick

Here it is, the moment you've all been waiting for: my inaugural stock pick!

Here is the ticker: NDAQ (Disclosure: I already own shares of NDAQ, and I may buy more without notice.)

Here is the background: this stock represents the Nasdaq OMX Group, Inc. You may have heard of the Nasdaq. It is an American stock exchange that introduced electronic trading, and they have revolutionized the way people trade stocks. It used to be that you would write a letter to your broker and he would have a trader up in New York try to get you a good price by shouting at a bunch of other traders some time the next week. Then Nasdaq came along, with Cisco, Apple, Microsoft, Sun Microsystems, et cetera, and introduced computers to stocks and stocks to computers. They have been innovating and dominating the stock exchange business ever since.

Of course, as the home of all the tech stocks worth noting, Nasdaq experienced a lot of pain in 2001 and 2002, when the tech bubble burst. This was necessary, because a lot of companies that should not have existed needed to be wiped out for the good of the country and for Pete's sake, and Nasdaq had been collecting listing fees from them in the meantime. It was bound to end. Well, Nasdaq had a public offering of their stock in the worst of times, the summer of 2002, and their stock promptly fell from there until more or less the autumn of 2004. Meanwhile their business and their profits had been growing. People started to take notice that a fast-growing company with a moat (that means new companies would have a heck of a time doing what they do) was available cheap, and the stock octupled from its 2004 lows in a little more than a year.

This great company had gotten no respect for a long time, was cheap, then people started to notice, and some people who bought in near its lows made several times their investment in a little more than a year. This story is told over and over again in the stock market. And it might be in the retelling for this particular stock a second time.

Nasdaq's revenue and profits from that revenue have been growing rapidly and consistently, peaking in the short term with the acquisition of the Swedish OMX Nordic Exchange and the high trading volumes prompted by recession fears; however, earnings will reach new heights in the not-too-distant future, if anything in this world is to be predicted.

For one, Nasdaq has been gaining on NYSE Euronext (NYSE ticker: NYX), their main American competitor, for years. Nasdaq is like the new bully who has come along and pushed the old bully down and taken her lunch money. NYSE is the old bully, and she's been losing market share to Nasdaq for years now. So if trading volumes and listings stay flat, Nasdaq has proved it can still increase profits by taking them from the NYSE.

Probably more importantly, OMX has an extra revenue stream from providing other exchanges with software and technology. They estimate that they have about 2% worldwide market share in this, and it is 35% of their revenue, coming from 60 different customers (these numbers are actually almost a year old - sorry I couldn't find more recent stats). This sounds like a growth opportunity to me.

I have read that Jim Cramer says he likes NYSE Euronext more than Nasdaq OMX, and I know he's certainly not alone in that. NYSE's stock (NYX) is trading for 20.90 times their earnings per share (EPS). In investing lingo, this means they have a P/E of 20.9; NDAQ's P/E is 8.45, despite repeatedly proving itself a faster-growing, better-managed, nimbler company than the NYSE. Somebody is not telling us something.

Well, there's a reason NDAQ's P/E is so low. Their EPS this past year reflects one-time sources of income and so forth, so that their forward P/E (their share price divided by their estimated EPS for the coming year) is 13.62. If you know anything about fast-growing companies, you know that's still a very low P/E for any company that's expected to grow at any time in the near future, let alone grow a lot very fast for the extent of the near future, and turn into one of the world's biggest, most profitable companies with a combination of brand power, technology, and business relationships.

The Risky Stuff
1. There is cause for concern over the quintupling of their debt load in the most recent quarter, though that is balanced by similar increases in assets. That is why it is called a "balance sheet."

2. Another possible concern is the operating cash flow (OCF) that is not growing the way revenue and earnings are. But the company is largely an investment company, and their investments drive a lot of growth in free cash flow (FCF).

3. Also, there are a lot of stock exchanges in this world that could provide competition and loss of pricing power, but at this point, they look more like potential acquisitions than they do like bullies of the future.

End of Risky Stuff

You might think I'm painting an overly rosy picture of Nasdaq's future. Okay, maybe I am. I have a lot of respect for the company and what they've managed to accomplish. Maybe they won't do as well as I think, and competition in the stock exchange space is going to be worse than I think, and unforeseeable things could go wrong. Maybe there are things I don't see, even though I searched high and low for a well thought-out reason not to buy NDAQ, and I couldn't find one. Well, a lot of that is already priced into NDAQ with it trading at < 15x estimated earnings for the coming year. The price of the stock is such that a lot of things could go wrong for the company, and you still would not lose very much money. If just a few things go right, you stand to profit tremendously. It seems likely to me that some of you will look back on these times and say "I can't believe I didn't buy stock in Nasdaq when it was trading for less than 10x earnings! Fleabagger said to, and yet I didn't believe him. What was I thinking!"

Spare your forehead the wrath of the palm of your hand. Buy NDAQ while it's still cheap.

NDAQ is trading for $33.50 in intraday trading as I prepare to post this on Friday, May 23, 2008 between 12:30 and 1:00 PM EDT. I would call NDAQ a serious buy anywhere below $40, and I would call $29 my "all-in" price, where young investors with gainful employment should put as much as they can in. As always, do enough research to own your own decision, consult your financial advisor or whatever, and remember that all stocks have the risk of severe capital loss. Neither The Fleabagger Portfolio nor its author is in any way responsible for any loss you suffer by acting on advice found on this space. You are responsible for your own investments and financial decisions.