Introduce any investor to three companies with 30%-plus operating margins, solid histories of double-digit revenue growth, incredibly low debt and growing dividends and you’d expect them to jump at the opportunity to invest. So, am I crazy for avoiding CMC (LSE: CMCX), Plus500 (LSE: PLUS) and IG Group (LSE: IGG) like the plague?
I fully acknowledge these firms are legitimate, well-run, cash-generating machines. My problem lies with the fact that they’re all contract for difference (CFD) and spread betting operators. These products offer retail investors the opportunity to make leveraged bets on the movement of assets, including equities, commodities and currencies.
Brokers make money through spreads and by charging a commission on every trade. And judging by the large profits each company records and hefty sums they spend recruiting new customers, the saying in gambling that the house always wins appears to apply equally well to these three firms.
Beginning with CMC, the newest of our trio to go public, operating margins over the past year were a very healthy 32% when factoring out the costs of going public. Dividends are also rising quickly for the firm thanks to its policy of returning 50% of post-tax profits to shareholders. Analysts are also pencilling-in a 3.9% yield for shares next year.
The most mature of the three, IG Group, recorded operating margins last year of an astounding 45.5%. Throw in an expected forward yield of 3.8% and it’s easy to see why shares of the company are up over 12% in the past year alone. Not bad for a £3.5bn company.
Plus500, which saw its proposed takeover by gambling software firm Playtech fall apart last year because of regulatory concerns, had operating margins that clocked in at a whopping 48% last year. And to make the company seem even more unbelievable, analysts are forecasting a 6.9% yield this year, even after share prices jumped 98% over the past 12 months.
So why my reticence about these firms? The biggest issue for me is the possibility of regulators clamping down hard on their operations.
Think back to the brouhaha and PR scandal that resulted from numerous retail traders being wiped out after Switzerland devalued the franc in early 2015. If another momentous event such as this were to happen, and more ‘mom and pop’ traders lost their shirts, it’s not hard to imagine that regulators would be forced to take drastic action. This wouldn’t be without precedent, as CFD trading has long been illegal for retail investors in the US.
Furthermore, Plus500 was embroiled in its own recent scandal, freezing over half of its UK customer accounts in May 2015, after scrutiny by the Financial Conduct Authority forced the company to review the accounts’ status under anti-money laundering regulations.
Another worry is the high amounts these firms spend on bringing in new customers. You only have to walk through the Tube in London to see ads for numerous brokers offering riches that are just a click away. This makes me believe that the firms could have high customer turnover.
These numerous adverts also lead into my final objection to investing in these three companies — the very narrow barrier to entry for competitors. High margins and eager punters are constantly attracting new companies which, together with regulatory headaches, is more than enough to make me avoid shares of these three.