One underdog stock I’m watching

It’s been a brutal six months for spread-betting and CFD provider, CMC Markets (LSE: CMCX). Shares have been on a downward trajectory since last December’s announcement by the Financial Conduct Authority (FCA) that it would be looking to introduce a new set of regulations to the £3.5bn industry to offer greater protection for “inexperienced” clients. 

Priced at 228p when they came to the market last February, shares dipped as low as 95p on the news. But was this reaction overdone? Let’s look at today’s set of full-year results. 

Profits slide

Some underperformance was to be expected. Over the year to the end of March, net operating income dipped 5% to just under £161m, leading pre-tax profits to fall to £48.5m — a 9% reduction on 2016’s figure. The number of trades made with the company declined 6% to 62.7m, their value also dropping by 3% to £2.02bn.  

On a more positive note, the number of active clients rose 5% to a little over 60,000. The 8.9p dividend per share was maintained and CMC still boasts a robust balance sheet.

The company also reported making “significant progress” on its five strategic initiatives, including signing the largest transaction in its history with ANZ Bank in Australia. Elsewhere, it had seen “strong growth” in its new offices in Poland and France, “rapid delivery” of new products to its platform and 82% growth in the value of trades made by institutional clients.

An improvement in financial performance at the start of the new financial year compared to the same period in 2016 had also been seen, even if — due to the proposed regulatory changes on the horizon — a cautious outlook was still being adopted. CEO Peter Cruddas reflected that these were likely to have “some impact” on the business but that CMC was “well positioned to benefit from market share gains in the medium and long term“. 

The shares were up over 6% this morning. Over the next few months, I suspect there may be more to come for two reasons.

Contrarian bet?

First, the spread-betting industry is driven by uncertainty and volatility. In short, CMC is a great company to hold if you suspect that market waters might become rather choppy. And should today’s election result in anything less than a convincing victory for the Conservatives, that is precisely what we’re going to get. Even if Theresa May does return to Downing Street tomorrow morning, there’s no shortage of potential political obstacles over the remainder of 2017 to drag markets down. 

This, of course, benefits companies like CMC (along with its larger peer IG Group) since clients are more likely to use their services. After all, an increase in volatility creates more opportunities for traders to profit.

Second, a watered-down set of regulations from the FCA could see sentiment towards companies such as CMC return in spades. Given the amount of opposition these proposals have generated so far, I’d be surprised if the initial suggestions were fully-enforced. Moreover, any new rules are likely to cause CMC’s smaller peers more distress, allowing the former to continue attracting new clients. 

Trading on 13 times forecast earnings for the next financial year, I remain stubborn in my belief that the market has overreacted and that holders of CMC could do well over time. A 5% dividend yield is adequate compensation while we await a final decision.