While 2020 has been a lousy year for the financial stocks in general, the stock exchanges have held up reasonably well, outperforming the banks and the real estate investment trusts. Despite a tough economic environment, initial public offerings (IPOs) have been strong, and commission-free trading platforms like Robinhood have contributed to increased volumes.
Nasdaq (NASDAQ: NDAQ) recently announced strong third-quarter earnings. Can the party continue?
Organic growth and operating leverage drive an increase in earnings
Nasdaq reported a 13% increase in revenue for the third quarter, driven almost exclusively by organic growth. Net market services revenue (less rebates and fees) increased 15%. Earnings per share increased 77% to $1.61 per share. Operating leverage, which occurs when revenue increases much faster than costs, was a big contributor to the increase in earnings per share.
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Options volume continues to rise, despite a sequential drop in volatility
While volatility has decreased from the second quarter, particularly the spikes of April and May, volumes remain elevated. On the earnings conference call, CEO Adena T. Friedman had this to say:
Our market infrastructure performed exceptionally well during the peaks of volatility we observed earlier this year, particularly in March and April. We continue to experience strong volumes across our equity options businesses in the third quarter, and we've continued to invest to enable us to have the capacity for future volatility as markets react to continually changing dynamics in the U.S. and globally.
U.S. equity options were a bright spot for the exchange, with average daily volume increasing to 28.1 million contracts -- a 56% jump from a year ago. In fact, despite the decline in volatility between the second and third quarter, average daily options volume increased 6% on a sequential basis. That said, cash equity trading volume declined to 9.9 billion shares from 12.4 billion shares in the second quarter. However, volumes were still up 43% compared to a year ago.
The highest number of IPOs in a decade
The capital markets environment has been favorable, with 105 IPOs listed on the Nasdaq during the quarter, the most in a decade. Nasdaq's win rate was 79% for listed companies, and if you include special purpose acquisition companies (SPACs), it comes out to 65%. Nasdaq increased its win rate in SPACs from 30% in the second quarter to 51% in the third. In addition, Nasdaq saw growth in index products, including a futures contract on Nasdaq volatility similar to the CBOE Volatility Index, better known as the VIX. The exchange is also launching ethical, social, and governance (ESG) derivatives.
In addition to earnings, Nasdaq announced the retirement of its Michael Ptasznik as CFO and the appointment of Senior Vice President, Controller, and Chief Accounting Officer Ann Dennison to the role. Finally, the company announced a quarterly dividend of $0.49 per share. The company has been buying back stock as well, purchasing $186 million worth of stock in the first nine months of the year.
Nasdaq's stock was recently up roughly 20% year to date, outperforming all of the other exchanges. Intercontinental Exchange (NYSE: ICE) is probably the strongest competitor, given that it competes in cash equities and options. In addition, ICE has been building a mortgage services business, which is an advantage in the best mortgage business in over a decade. CME Group (NASDAQ: CME) is struggling with a decline in bond market volatility and the effect of having interest rates below zero.
Nasdaq was recently trading at 22 times expected 2020 earnings per share and has a 1.5% dividend yield. If we see a spike in volatility as a result of the election, Nasdaq should be a big beneficiary. Investors who are also nervous about a resurgence of COVID-19 and a corresponding decline in economic activity would do well to put some money in the exchanges, since they would be largely insulated from a weaker economy and would benefit from any sort of cataclysmic sell-off.
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Brent Nyitray, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends CME Group and Intercontinental Exchange. The Motley Fool recommends Nasdaq. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.