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This stock is underperforming the FTSE 100. Is it time to buy?

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Bus waiting in front of the London Stock Exchange on a sunny day.
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As companies go, I think London Stock Exchange (LSE: LSEG) is a great one. But this year, the share price has fallen a disappointing 20%, while the FTSE 100 index is up a respectable 13%. 

Is the market telling me something I should know? Or has this share price weakness presented me with a buying opportunity? Let’s take a closer look.

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A wide economic moat

The reason I think London Stock Exchange is a great business is due to its economic moat. This phrase was popularised by Warren Buffett and ultimately means a company can maintain market share . Here’s what he said at Berkshire Hathaway‘s annual shareholder meeting in 1995: “What we’re trying to do is we’re trying to find a business with a wide and long-lasting moat around it, protecting a terrific economic castle with an honest lord in charge of the castle.”

LSEG has a terrific economic castle, in my view. Its operating margin is consistently around the 40% mark, and return on equity is in the double-digits.

I also think the moat is wide, and long-lasting. It would be very difficult for a competitor to set up a rival stock exchange as the LSEG is ingrained in the UK’s financial services industry. This is as close to a monopoly as business gets.

It all sounds great so far. But why has the share price underperformed this year?

Results and an acquisition

The share price was actually up 14% in February, settling at close to £100. But in March, the shares crashed, hitting a low of £69. The share price fell over 14% on one day alone, so there must have been a reason.

The steep one-day fall occurred on the same day its final results to December 2020 were released. Revenue grew 6%, and adjusted earnings per share rose 5%. Growth wasn’t spectacular then, but I don’t think it warranted a 14% fall in the share price.

It was the acquisition of Refinitiv, first announced back in August 2019, that seemed to be the catalyst behind the share price plunge. The $27bn all-share deal finally completed in January this year, but guidance in the final results was for costs to increase by mid-single-digits.

Citigroup at the time said that the extra £150m of operating costs will recur in 2022 and beyond, and proceeded to lower its rating on the stock to ‘neutral’ from ‘buy’.

Refinitiv and outlook

I do understand the concerns over rising costs. Refinitiv is a legacy platform, and it will need considerable investment to upgrade and integrate into the wider London Stock Exchange business.

I’m optimistic about the potential here, though. The combined data and analytics capabilities of both companies should make it a leader in the industry and widen the economic moat.

The shares currently trade on a forward price-to-earnings ratio of 25, which seems reasonable to me. I’ll be looking to buy at this valuation.

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Dan Appleby owns shares of London Stock Exchange. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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