After spiking yesterday following the conclusion of the Federal Reserve's June monetary policy meeting, U.S. stocks are roughly flat on Thursday morning, with the benchmark S&P 500 and the narrower Dow Jones Industrial Average (DJINDICES:^DJI) up 0.04% and 0.01%, respectively, at 10:20 a.m. EDT. In a market that appears increasingly expensive, financial data provider Markit (NASDAQ:INFO), which begins trading on the Nasdaq today, looks like it could outperform the broad market over the next several years (although that outcome will depend on the magnitude of the first day "pop" the shares enjoy as they begin trading).
For long-term investors, most IPOs aren't worth paying any attention to. Why? Most businesses are simply mediocre and, therefore, unsuitable for long-term ownership. Every so often, however, a superior company goes public. That's the case of Markit.
The Buffett-like company was founded in London in 2003 and provides financial market information (securities prices, index data, etc.) to over 3,000 institutional clients. That information is used by staff who work across the life cycle of a trade, from portfolio managers to back-office workers. Why do I refer to Markit as a Buffett-like company? These two points, from the company's offering document, in which Markit describes its "attractive financial model," ought to help clarify:
High Recurring Revenue : We offer our products and services primarily through recurring fixed fee and variable fee agreements, and this business model has historically delivered stable revenue and predictable cash flows. Many of the capabilities that we provide are core to our customers' business operations, deeply embedded in their existing workflows and difficult to replace... for the year ended December 31, 2013 and the three months ended March 31, 2014, our renewal rate of recurring fixed fee contracts was approximately 90%.
High Cash Generation : Our business has low capital requirements for product maintenance and development, allowing us to generate strong cash flow.
Note that the text I have marked in bold pertains not simply to its financial model, but to the strength of the company's competitive moat. A wide moat and low capital expenditure requirements are two of Buffett's favorite attributes in a business (nevertheless, I don't think Buffett himself would invest in Markit, as there is a technological aspect to it that he might not be comfortable with).
If I invoke Warren Buffett, I can't neglect to say something about valuation; on that basis, Markit shares don't look particularly cheap (that's not uncommon for a superior business, particularly during a flotation). At its IPO price of $24, Markit's stock is valued at 33.3 times pro forma earnings per share for the trailing 12-month period to March 31, 2014.
Still, all hope may not be lost. When Markit's closest public market comparable, MSCI (NYSE:MSCI), floated in November 2007, the shares were priced at $18, or 30.0 times pro forma earnings per share for the fiscal year ended Nov. 30, 2007. Nevertheless, they have smashed the market's performance since then: On the basis of price return, the shares are ahead of the S&P 500 by more than 40 percentage points, cumulatively. MSCI's stock continues to trade at a premium to the market; as of yesterday's close, it was valued at 19.4 times estimated earnings per share for the year ended Dec. 31, 2015.
Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.