Investing in Investing

Rupert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

"Reuters: Investors in funds worldwide poured $11 billion into U.S. stock funds in the last week of January, the most since September 2011, as the Dow Jones industrial average flirted with the psychologically important 14,000 level, data from EPFR Global showed on Friday.

The solid demand for stock funds last month was a sharp contrast from 2012. Investors have given $53.8 billion to stock funds worldwide in the past four weeks after having pulled $69.1 billion from the funds last year."

This is a growing trend. As global stock markets reach all-time highs, retail investors are moving more and more money back into stocks. In addition, there is a growing trend in foreign exchange trading as movements in the yen and a recovery in the euro bring traders back into the market.

A quick search on Google search trends highlights the increasing searches by consumers looking for online investment brokerages.

Where to invest?

So, where would be the best place to invest to take advantage of these inflows? The obvious idea is to buy stock in the exchanges themselves, e.g. NYSE Euronext or the NASDAQ OMX Group (NASDAQ: NDAQ). However, all of these in my opinion have margins that are too small and are locked in fierce competition with each other.

Oh the other hand, there are the asset managers such as Invesco (NYSE: IVZ) and Blackrock, who could present an investment opportunity, although I would rather buy one of their funds on offer. Investment banks are the next option but once again as with exchanges, there are too many additional risks that could affect banks going forward.

Finally there are the brokers themselves as listed above, namely E*TRADE FinancialCharles Schwab and Interactive Brokers (NASDAQ: IBKR).

I believe there are three main companies to buy to play this resurgence in investing.

NASDAQ OMX Group

While I said that I did not think that the investment brokerage looked to be a good investment, NASDAQ looks to be a good bet. NASDAQ operates exchanges all over the world and in the group's trading volumes document, the company notes that in January, European options and futures volumes were up roughly 25% from the 2012 average. The company also noted that European and US equity volumes were also up.

NASDAQ saw its share of the US options market move up to 30% from 27% in the year before. However, the group's share of trades placed in the US equity market fell from 21% to 19% during 2012. That said, the group did see an increase in its revenue per 1,000 shares traded, up more than 20% from $0.33 per 1,000 shares at the beginning of 2012, to $0.40 per 1,000 shares at the end of 2012.

Invesco

Shares in Invesco could be one of the best ways to play the resurgence in fund inflows. While I have mentioned that I would rather by a fund, shares in the company could offer a better alternative for cash inflows. While a fund would benefit from the market moving higher, there would still be management fees to pay.

On the other hand, owning Invesco directly would mean there is no management fee and the company will make money even when the market is going down. A fund would not make money during a market downturn, but there would still be management fees to pay. All in all, owing Invesco stock could be a win-win situation.

Despite having a poor fourth quarter, the company notes thatJanuary has been an extraordinary month in terms of flows coming back into a whole range of our products.”

Invesco is smaller and cheaper than its larger peer Blackrock, trading at a forward P/E of only 12 compared to Blackrock's 14.

Interactive Brokers

While not the biggest of the brokers, I believe Interactive is the best value. Tiny in size compared to the $25 billion Schwab, Interactive has a much better profit margin of 45%, which has produced a return on shareholder equity of 65% for the last year. In addition to its efficiency, the company currently looks cheap trading at a P/E of 16 compared to the sector average of 20. Interactive has a cash value per share of $34, giving the company a cash-to-share price ratio of 0.5.

If companies make more money, will shareholders be rewarded?

This is a key question, it is often the case that companies will see an increase in profits but do not return these to shareholders. Based on historic returns, which one of these three firms will produce the best returns for shareholders?

Interactive Brokers

$US Millions

2010

2011

9 months 2012

Dividends paid

75

14

30

Stock Brought back

28

1

-

Total

103

15

30

As a % of Net Income

-

24%

95%

Interactive Brokers returned a significant amount of cash to shareholders during 2010. However, the company reported a net loss for the year of $9 million so it is impossible to calculate this figure as a percentage of net income. During 2011, the company returned 24% of its net income to shareholders, mostly through dividends.  For the first nine months of 2012, Interactive returned 95% of its net income back to shareholders, this was entirely through dividends, which I believe is the best way to return cash to shareholders. 

NASDAQ OMX Group

$US Millions

2010

2011

9 months 2012

Dividends paid

-

-

65

Stock Brought back

791

90

448

Total

791

90

513

As a % of Net Income

200%

23%

192%

During 2010 and for the first nine months of 2012, NASDAQ returned more than 190% of its net income to shareholders. Unfortunately, this is an unrealistic figure so I doubt it is sustainable. Stock buybacks were the bulk of this cash return and this has translated in shareholder returns as the stock is up 50% since 2010.

Invesco

$US Millions

2010

2011

9 months 2012

Dividends paid

197

220

244

Stock Brought back

172

424

242

Total

369

644

486

As a % of Net Income

79%

88%

71%

Invesco has been the most consistent returner of cash to shareholders. The company has returned, on average, over 70% of its net income per year to shareholders. For the most part, this cash return has been evenly distributed through both buybacks and dividends. For shareholder returns, Invesco is the most consistent company.

Overall

Investors are getting back into stocks and the best way to play this appears to be Invesco. Despite the fact that brokerages and exchanges are trading higher volumes of stock, this may not translate into higher shareholder returns. Overall, to take advantage of the great rotation back into stocks, Invesco seems to be the best play.


RupertHargreav has no position in any stocks mentioned. The Motley Fool recommends Interactive Brokers. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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