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Diversify Your Portfolio While Beating the Market With This Company

By Josh Kohn-Lindquist – Aug 24, 2021 at 6:57AM

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Nasdaq offers immediate tech diversification and growth optionality at a market capitalization well below its peers in the index and exchange industry.

Market capitalization is probably the most straightforward valuation metric that an investor can use, but it is one of my favorites. Market cap simply quantifies the market's overall value for a company once removing its debt. Mathematically speaking, market cap equals the number of shares outstanding times its current share price. The innate beauty behind market cap is that it removes the "price tag" from a company and looks at the whole business.

For example, Nasdaq's (NDAQ -0.96%) market cap today sits around $31 billion, which gives me a general sense of the company's size. However, looking at its $190 price tag tells us nothing, at least until other "per-share" metrics give us various valuations. By avoiding these per-share valuations, I am allowed to ask, do I agree with the market's overall valuation for Nasdaq? Simply put, no. I would've guessed it to be closer to the $75 billion or higher range.

Far from scientific, this simple test nonetheless highlights the brand power Nasdaq holds in my mind and is an excellent first step in identifying it as potentially undervalued. In addition to this potentially undersized market cap, Nasdaq offers broad tech diversification and incredible optionality for investors looking to outperform the market.

Young person uses a smartphone ouside in the evening against a backdrop of skyscrapers.

Image source: Getty Images

Diversification via public and private markets

One appealing characteristic of an investment in Nasdaq is its broad diversification across the technology industry. Through the 4,500-plus companies listed on the Nasdaq exchange, the company continues to play a vital role in taking hundreds of significant tech companies public. Furthermore, Nasdaq can offer various services to these companies on their exchange, ranging from investor relations (IR), environmental, social, and governance (ESG), analytics, and surveillance. The beauty of these services is that they are all incredibly sticky sales and fit nicely into the company's growing subscription as a service (SaaS) business model. As the company has continued diversifying its business operations, it has become less reliant on its transaction-based market services segment and more on annually recurring revenue.

Nasdaq's diversification potential through the upcoming spinoff of its Nasdaq Private Market (NPM) also excites me. Albeit indirectly, investing in the company offers investors the opportunity to participate in the booming private market home to hundreds of up-and-coming "unicorn" businesses. (Companies earn the unicorn moniker if they are privately held businesses with a valuation of over $1 billion.) As individual investors are generally unable to participate in these private companies' growth until they IPO, NPM's new joint venture gives us a chance to backdoor into some valuable exposure to this restricted market. 

Through this upcoming spinoff and Nasdaq's four distinct operating segments, the company offers fascinating growth optionality that may be a hidden value due to its complexity.

Its growth potential is hidden by complexity

SaaS companies are some of the most heavily targeted investments today, often pairing recurring revenue with the potential to upsell adjacent products and services to clients. However, Nasdaq seems to go unnoticed as a SaaS company, despite having grown SaaS sales as a portion of annualized recurring revenue (ARR) from 21% to 34% over the last five years. Due to this blend of revenue sources, it is difficult to apply any specific set of valuation metrics to the company, which is why I believe market cap offers the best attempt at valuing Nasdaq.

Further clouding Nasdaq's valuation, the company operates in four adjacent yet unique business segments listed below:

Business Segment

Net Revenue (Q2 2021)

Operating Margin (Q2 2021)

Revenue Growth (YOY) 

Market services

$312 million

65%

13%

Corporate platforms

$154 million

42%

22%

Investment intelligence

$263 million

65%

23%

Market technology

$117 million

15%

39%

Data Source: Nasdaq Q2 2021 Earnings Presentation.

Because the bulk of market services revenue are transaction-based, Nasdaq may never qualify as a complete SaaS company, but it is slowly moving in that direction. As Nasdaq looks to spinoff its private market, I am watching for the company to simplify its operations, both in its business segments and its types of revenues. It appears management is taking the initial steps toward streamlining its operations and unlocking value for shareholders. Nasdaq's leaders are aiming for SaaS revenue to account for 40% to 50% of total revenue by 2025.

An investor's next move

Nasdaq is an operationally complex yet financially sound business in the early stages of unlocking shareholder value. Currently maintaining a profit margin of 19% and a return on equity (ROE) of 18%, Nasdaq is a genuine cash cow. These metrics are 40% and 69% higher, respectively, than the company's five-year averages, demonstrating the impact of its growing SaaS sales.

This profitability, paired with its growth optionality and its exposure to the public and private tech markets alike, makes Nasdaq a promising opportunity to outperform the market. Finally, with a market cap of $31 billion, Nasdaq's perceived overall market value is much lower than its peers:

  • Coinbase Global (COIN -1.03%): $54 billion market cap
  • S&P Global (SPGI -1.67%): $105 billion market cap
  • Intercontinental Exchange (ICE -0.86%): $66 billion market cap

Should Nasdaq eventually grow to the size of its fellow indexer S&P Global from today's market valuation, it would represent three-times upside in shares of the company today.

Going forward, I will be watching for updated guidance on SaaS sales as a percentage of the company's overall revenues, as Nasdaq appears to be a quickly growing SaaS company hiding behind a slowly simplifying operating structure.

Josh Kohn-Lindquist owns shares of Nasdaq. The Motley Fool owns shares of and recommends S&P Global. The Motley Fool recommends Intercontinental Exchange and Nasdaq. The Motley Fool has a disclosure policy.

Stocks Mentioned

Nasdaq Stock Quote
Nasdaq
NDAQ
$68.32 (-0.96%) $0.66
Intercontinental Exchange Stock Quote
Intercontinental Exchange
ICE
$108.31 (-0.86%) $0.94
S&p Global Stock Quote
S&p Global
SPGI
$353.81 (-1.67%) $-5.99
Coinbase Global Stock Quote
Coinbase Global
COIN
$47.18 (-1.03%) $0.49

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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