Last week, investment index provider MSCI (MSCI -1.26%) reported its second-quarter earnings. The numbers pointed to increasing recurring revenue and profitability. But the star of the show was the company's ESG and Climate segment. Let's take a closer look.

ESG has joined the party

MSCI recently reported that its Q2 revenue was up 11% to $552 million, and adjusted earnings per share rose 13% to $2.78. Embedded in the quarterly numbers was 8% organic growth in the overall company and organic growth across three of its four business segments, including its ESG and Climate segment.

MCSI is best known for its international stock index business, which provides index data to investment companies that benchmark their performance against MSCI's widely recognized indexes. For instance, an international mutual fund may license data from the company's MSCI World index. The mutual fund can then show its performance to investors and include it in marketing materials. Some index mutual funds or ETFs seek to match MSCI's indexes exactly. Those customers are so entrenched in MSCI's index they use the MSCI trademark in the name of their mutual fund or ETF, like iShares MSCI World ETF.

Person sitting at a computer happy about the stock chart on the screen.

Image source: Getty Images.

About 41% of MSCI's index-segment revenue is derived from fees based on assets under management, held by its investment-company customers. Due to customer AUM declines, MSCI's AUM-based revenue shrank during the quarter. However, the bulk of revenue from the segment is subscription-based and recurring in nature. Despite the drag from AUM-based revenue, subscription growth propelled the entire segment to 5% organic growth. Sales increased from $306 million in last year's Q2 to $320.9 million.

MSCI's analytics segment provides risk-management data, including market, credit, liquidity, and climate risk, used by investment companies in their investment processes. Nearly all revenue from this segment is subscription-based. With today's risky market environment, MSCI's analytics segment increased 5% organically in the quarter to $141.7 million.

Perhaps the most encouraging sign for MSCI came in its ESG and Climate segment, which helps investment customers understand ESG regulation, meet client demands, and integrate ESG into their investment philosophy. Incorporating ESG, or environmental, social, and governance, criteria into the investment world has garnered much attention over the last several years.

Investment companies looking to make their services more ESG-friendly have flocked to MSCI's services. During Q2, the company's ESG and Climate segment reported a head-turning 47% organic rise in recurring subscription revenue to  $55.1 million. Going back further, the segment has been growing rapidly since 2017.

Chart showing organic growth of MSCI's ESG & Climate segment since 2017.

Company presentation.

Buy the dip?

MSCI stock is down 20% over the past 12 months. The fall may be attributed to fears that AUM-based business could be a drag on the company. Ironically, the MSCI World Index is down 14% over the past year. Investors may be unaware that the vast majority of MSCI's business is recurring and not based on the rise and fall of fees based on AUM.

To bolster the investment case for MSCI, the company is wildly profitable. Its Q2 net income climbed to $211 million from $165 million last year. In addition, the company's earnings before interest, taxes, depreciation, and amortization (EBITDA) margin rose to 60% from 59.2% in last year's Q2. For the full year of 2022, MSCI forecasts free cash flow of over  $1 billion.

The short-term risk to the stock is that MSCI's stock indexes continue to fall and bring down AUM-based revenue and profit. But MSCI's growing recurring revenue base, combined with the stock's decline over the last year, may offer long-term investors an opportunity to buy the dip.