At first glance, CME Group (CME 1.09%) and the Intercontinental Exchange (ICE +0.04%) seem pretty similar.
Both manage huge exchanges and are in the business of providing a platform for investors to buy and sell securities. Both make their money on transaction fees and charging investors for real-time data. CME Group concentrates mainly on derivatives contracts-futures and options, while the Intercontinental Exchange trades futures, options, and stocks.
But which stock is the better bet right now? Let's take a closer look at the two and see what determination can be made.
Image source: Getty Images.
A little background and a valuation comparison
The CME Group's roots began with open-outcry commodity trading in Chicago. Established in 1898, the CME began life as the Chicago Butter and Egg Board. The Chicago Mercantile Exchange and the Chicago Board of Trade merged in 2007 and then joined up with the New York Mercantile Exchange to become the largest futures and options exchange in the world. The CME Group trades equity indices, interest rate derivatives, and foreign exchange derivatives. In the fourth quarter, average daily volume of futures and options trading on the CME totaled 16.7 million contracts, with an average revenue per contract of $0.717.
The Intercontinental Exchange began as an electronic energy trading platform in 2000. It grew by acquiring the International Petroleum Exchange, the New York Stock Exchange / Euronext, and has expanded into the mortgage space and even into cryptocurrencies. The company trades nine asset classes and has 13 exchanges globally. According to its 10-K for 2019, the average daily volume for ICE futures is 5.7 million with an average revenue per contract of $1.12.
| Stock | 2019 P/E | 2020 P/E | Dividend Yield |
|---|---|---|---|
| CME Group | 35.1 | 28.4 | 1.45% |
| Intercontinental Exchange | 27.9 | 22.8 | 1.15% |
Source: Company filings
CME Group stock is more expensive than Intercontinental Exchange's stock. The difference is largely explained by margins -- CME has 54% operating margins, compared with ICE's 39% margins. CME also has a higher dividend yield -- 1.45% versus 1.15% --and slightly higher earnings growth. On a valuation basis, the difference isn't substantial. For determining the better of the two, we can call it a push.
Beware the calls for a financial transactions tax
The financial transaction tax (FTT) is an idea that has been in vogue for a while now, especially with the Democratic Party. U.S. Senators Elizabeth Warren and Bernie Sanders -- who are also 2020 presidential candidates -- support the idea, as does presidential candidate and former New York City Mayor Mike Bloomberg. While details are sketchy on amounts and implementation rules, the tax on stock exchange transactions is said to be anywhere from 10 basis points to 50 basis points.
What would that tax do to trading volume? For the Chicago Mercantile Exchange, probably not much, since much of the activity on that exchange is related to futures and options contracts, where wider bid/ask spreads are normal, and the motivations of traders are different. For example, if an airline is using the exchange to hedge fuel price exposure, an extra 10 basis point tax isn't going to make a difference to them -- it is just another cost of doing business. Even a hedge fund which makes macro bets, or uses options to hedge a position, won't be bothered.
But for the Intercontinental Exchange, which owns the New York Stock Exchange, the effect would be to kill (or severely limit the profitability of) high-frequency trading (HFT). That's is a big deal. Cash equities and options accounted for 42% of ICE's revenue last year. Estimates vary for the volume share of HFT on the NYSE, but it is generally assumed to be at least half.
High-frequency trading has taken over much of the market-making function that used to be performed by the specialist on the NYSE trading floor. HFT is also a speculative activity, often front-running orders and holding stocks for a second or less, looking to scalp a quarter of a penny out of each share traded. On a $15 dollar stock, that is 2 basis points. If a financial transaction tax imposes a 10 basis point fee on that trade (let alone 50 basis points), it will kill the profitability of the activity.
Of course, whatever law ends up getting passed will probably make some sort of bonafide market-making carve-out, which means that traders who are contributing to liquidity would be exempt, but those using liquidity would pay. Regardless of how the law would be structured, the speculators will exit the business.
Either way, the imposition of an FTT will affect volume on the New York Stock Exchange way more than, say, the New York Mercantile Exchange.
More competition is coming
Another potential issue coming this summer for the two financial companies relates to the news that Goldman Sachs and JPMorgan Chase, along with Virtu Financials and Citadel Securities, are launching a new stock exchange called Members Exchange (MEMX) which will compete with the NYSE and NASDAQ. This new exchange hopes to undercut traditional exchanges by offering rock bottom fees, with fewer complex order options and a cheaper data feed.
The new exchange will go live on July 24. Virtu and Citadel account for about 40% of the volume on the U.S. exchanges, so the loss of that volume will directly affect ICE's revenue. So, while CME Group may be more expensive on a P/E basis, ICE Group has some major challenges ahead of it.
ICE may have to rely on acquisitions to grow or build out its cryptocurrency exchange Bakkt. The valuation discount of ICE isn't enough to offset the risks going forward.
Which is the better investment?
Overall, ICE has some threats that CME does not. While a Democrat being elected in 2020 doesn't necessarily mean a financial transaction tax is coming, it has been mentioned as a goal by several candidates. Politically, anything can happen and the size of the tax matters greatly. A 50 basis point tax would be a huge deal. A 10 basis point tax would have less impact.
The introduction of MEMX will directly attack the NYSE's trading and data fee business as its biggest customers leave. That said, ICE management has been sanguine about the MEMX launch and says it will not fight it. ICE has even said it envisions MEMX could have spillover benefits for the NYSE.
In summary, with their valuations being similar and CME appearing to have fewer overall risks in the near term than ICE does, I'd have to say CME Group is the better buy right now.
