Is the worst over for these spread-betting stocks?

Should you buy these unloved spread betting firms following their recent share price performance?

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The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Shares in spread betting firms IG Group (LSE: IGG) and CMC Markets (LSE: CMCX) recovered slightly today, after a combined £1.4bn was wiped off the value of both companies following yesterday’s announcement that the Financial Conduct Authority (FCA) is proposing stricter rules on contracts for difference (CFDs) products, which includes spread betting.

New rules

The FCA wants to introduce new rules to protect retail customers from making unexpected losses from risky bets on the financial markets. The proposed measures include standardised risk warnings, mandatory profit-loss disclosures, limits on leverage and the curbing of account opening bonuses.

These rules weren’t aimed at IG or CMC, as they have been seen to have better practices in place for recruiting new clients and have tended to operate at the higher end of the market. Nevertheless, both IG and CMC will still be hard hit by the implementation of the proposed new rules. That’s because the outcome of the FCA’s proposed rules would be a much smaller CFD market, in which there will be no winning firms.

Not so bad?

That said, it’s not unusual for a regulator to sound tough initially, but later succumb to industry pressure — look at the Competition and Markets Authority’s (CMA) recent decision to reverse a previous ruling by Ofgem to compel price comparison websites to show all energy deals on offer. The FCA is currently still in the consultation phase, and is unlikely to make a final decision until late 2017.

Moreover, regulation may not entirely be a bad thing for IG and CMC. Stricter rules tend to encourage industry consolidation, as new rules generally hit the smallest firms hardest. This could help bigger firms to grow market share, gain benefits of scale and boost profitability.

Also, the proposed new rules may improve client outcomes and help the industry to sustain a larger active client base. Spread betting firms spend loads of money chasing new customers because some 80% of their retail clients lose money – if fewer clients lose money, maybe firms could find it easier to keep their existing ones.

Tough trading

Unfortunately, CMC Markets hadn’t been having it easy even before the latest FCA proposals. It listed on the London Stock Exchange in February this year at an IPO price of 240p a share, but for much of the time it has been trading, the shares were valued at less than its IPO price.

The company’s shares plunged in September after it warned low levels of volatility were causing client trading activity to fall. And last month, CMC reported a 29% decrease in earnings per share for the six months to 30 September 2016, as the value of trades fell 18% to £911bn.

That said, there’s good news too. CMC was able to continue to grow its client base, with the number of active clients up 8% to 47,623, while client assets rose a staggering 32% to £283m. This implies that clients were indeed finding fewer trading opportunities and haven’t abandoned their accounts at CMC. The worst may not be over, but not everything points towards more downside.

Right now, shares in CMC trade at 7.3 times its expected 2017 earnings, which is significantly below IG’s forward P/E of 10.2.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Jack Tang has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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