Bull markets in equities are generally good things for the stock exchanges. Higher prices mean higher trading volumes and more fees.
Intercontinental Exchange (ICE +0.04%) and Nasdaq (NDAQ +0.08%) have been bright spots in the financial sector lately. Robinhood traders have been chasing the latest market darlings, which has boosted volumes, and as a result the markets have been hitting new highs. Stock exchanges have been a great place to be. But which one is the better buy?
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Intercontinental Exchange is best known for the New York Stock Exchange, but it has other valuable assets too. Euronext is Europe's biggest stock exchange, and the New York Board of Trade is a major U.S. derivatives exchange.
More than just exchanges
Intercontinental Exchange earns trading and clearing fees, and it sells data to media and financial firms. In addition, Intercontinental Exchange has a mortgage arm, which provides services to the mortgage industry. Intercontinental Exchange's mortgage technology business includes the Mortgage Electronic Registration System (MERS), which provides title and servicing information for mortgage lenders, servicers, and borrowers. This segment also recently acquired Ellie Mae, which provides mortgage services to mortgage lenders.
Nasdaq is the other major U.S. stock trading venue. Like Intercontinental Exchange, Nasdaq earns trading and clearing fees and sells its data. Nasdaq also has some ancillary businesses, including corporate services, which provide listing and governance solutions. Nasdaq has benefited from the advent of commission-free trading, particularly via Robinhood investors, which is driving increased volumes. In the third quarter, average daily volumes were up 58% to 28.1 million shares.
Given that both companies have hard-to-replicate business models, they tend to have high multiples for financial companies. Intercontinental Exchange currently trades at a 2021 price-to-earnings ratio of just under 24, while Nasdaq trades at a 2021 P/E of just under 22. Intercontinental Exchange is expected to show 6% earnings-per-share growth between 2021 and 2020, while Nasdaq is expected to be about flat.
ICE PE Ratio (Forward) data by YCharts
Bullish on the mortgage sector
If stocks' bull market continues, both companies should benefit. That said, Intercontinental Exchange's mortgage arm provides the possibility for more growth. The Ellie Mae transaction was completed in early September, so its effect wasn't really reflected in 2020 numbers. The mortgage business will be at the mercy of interest rate movements; however, the Fed currently forecasts no rate increases for at least a couple of years.
Not only that, but according to some estimates, over 32 million borrowers will be able to save 0.75% on their mortgage rate by refinancing. Last year was the best for the mortgage origination business since the early 2000s, and given the demand for mortgages and a benign interest rate environment, the boom could last a bit longer.
The Mortgage Bankers Association is forecasting a decrease in origination volumes in 2021, but that is based on a forecast for rising rates in the second half of the year. If rates stay stable, those estimates will rise. Even if rates tick up, mortgage bankers may get more competitive to drive business. As a service provider, all the mortgage arm needs is volume.
One has an edge
So, which one is the better buy? I would have to side with ICE simply because I am bullish on the mortgage sector. The Fed recognizes that one of the easiest ways to get money in the hands of people is to lower their mortgage payment. Since it can directly affect mortgage rates via its purchases of mortgage backed securities, it has a lot of say in the matter.
As long as unemployment is elevated and the economy remains in a COVID-weakened state, the Fed will keep mortgage rates low. The mortgage arm will provide some upside potential to Intercontinental Exchange's earnings estimates for next year. Given that potential upside, I like Intercontinental Exchange over Nasdaq, despite the slightly higher multiple.
