MSCI - Corporate quality meets growth
MSCI is a leading provider of equity indices (e.g. known as the creator of MSCI World), risk management tools and ESG data solutions used by fund providers, asset managers and institutional investors worldwide.
MSCI generates the majority of its revenue (58%) from index licenses - i.e. for clients using MSCI indices in their investment products such as ETFs, funds or derivatives. This income is mainly based on fixed, recurring license fees and is supplemented by volume-based fees: the more capital is managed via an MSCI product, the higher the fee. In total, around 97 % of revenues are recurring - This ensures a high degree of predictability and makes the business model particularly crisis-resistant.
Together with S&P Global $SPGI (+2,17%) and FTSE Russell, MSCI dominates the market for equity indices - these three companies alone account for >70% of the market.
Put simply, MSCI will grow as long as the following points are true:
- Clients choose MSCI as their index provider (there are only the three major providers mentioned above to choose from)
- Customers' investment products based on an MSCI index receive an inflow of funds (e.g. due to the increasing trend towards passive investing via ETFs)
- Long-term rising stock markets
If you are interested, I can go into more detail about MSCI another time. Today I would like to illustrate the powerful mechanics of quality and growth using MSCI as an example.
Criterion 1: Company quality
Here are some points that make MSCI a quality company:
- Dominant market position in the index business: MSCI is one of the leading providers of equity indices worldwide and has established itself as the market standard with benchmarks such as the MSCI World or MSCI Emerging Markets. Many institutional investors and ETF providers use MSCI indices as a reference, which leads to strong customer loyalty and high switching costs.
- Pricing power: Thanks to the strong market position and deep integration of its products with clients, MSCI can regularly enforce price adjustments without risking high client churn. Customers are often heavily dependent on the indices and analysis systems.
- Recurring, predictable revenues: Much of the revenue is recurring and based on long-term license agreements or volume-based fees, such as depending on clients' assets under management (AUM). This means that revenues are very stable and easy to forecast - even in fluctuating market phases.
- High scalability: MSCI distributes largely digital and data-driven products, which means that new clients can be served with little additional effort. This leads to attractive economies of scale and rising margins with growing sales.
- Diversification of revenue sources: In addition to the index business, MSCI generates further revenue from areas such as ESG data, climate risk models, portfolio analysis and real estate valuation. This diversification makes the company less dependent on individual segments or short-term market trends.
- High management quality: The management pursues a long-term strategy with a focus on sustainable growth, efficiency and innovation. A high degree of discipline and clarity is evident in communication and implementation.
- Capital allocation: MSCI makes targeted investments in high-margin growth themes, makes complementary acquisitions and uses excess capital for sensible share buybacks. Capital allocation is focused, shareholder-friendly and growth-oriented.
Criterion 2: Growth
MSCI is growing steadily, albeit not explosively: since 2015, the company's turnover by an average of 11.5 % per year (see chart below).
Over the same period, the company has increased its net profits faster (19.5% per year) than sales - a classic sign of a high-quality, scalable company (see chart below).
Main reasons: Increased sales hardly lead to additional costs, better operational efficiency with increasing size, disciplined cost control and regular price increases.
MSCI was able to convert these profits very efficiently into free cash flow into free cash flow. Since 2015, net profit has increased by an average of 19.5% per year - free cash flow by as much as 20.2% per year (see chart below).
Free cash flow is the money that actually remains in the company after all expenses - i.e. what can be used, for example, to repay bank debts, buy back shares, pay dividends or take over other companies.
MSCI therefore not only manages to operate profitably, but also to convert a very high proportion of these profits into real money - a sign of:
- high capital efficiency
- a lightweight, digital business model with low capital expenditure
- and strong financial control of the company
Even more important than free cash flow, however, is free cash flow per share increased even more than free cash flow: by an average of 24.7% per year (see chart below).
The free cash flow per share shows how much real money flows to each individual shareholder per year. The fact that this figure is growing even faster than the total cash flow is due to the fact that MSCI has simultaneously reduced the number of outstanding shares due to its high profitability - through regular share buybacks (see chart below).
This is particularly attractive for investors: Even if you don't buy any additional shares, your stake in the company grows automatically because there are fewer shares of the company. This shows that MSCI not only works efficiently in operational terms, but also deploys its capital in a disciplined and shareholder-friendly manner.
The share price of a company follows the free cash flow per share over the long term. MSCI is no different: as mentioned, free cash flow per share has risen by an average of 24.7% per year since 2015, while the share price of MSCI increased by 25.0% per year over the same period (see chart below).
As the development of the free cash flow per share and the share price are almost congruent, this implies that the valuation of the company has increased only insignificantly. This can be clearly seen from the fact that the ratio between the share price and free cash flow (P/FCF) has risen only minimally between the end of 2015 and today (see chart below).
In other words: the rise in MSCI's share price is predominantly due to more sales, higher profits, higher cash flow and share buybacks, and not due to a rising valuation - which is positive. In fact, if investors give the company a higher valuation for the free cash flow per share that the company generates, then this actually offers potential for a higher share price.
Over the long term, MSCI's strong operating performance has clearly outperformed an index such as the S&P 500 ("SPY") clearly outperformed (see chart below).
In the last 5 years, however, the S&P 500 ("SPY") the nose ahead (see chart below).
On the one hand, this speaks for the the outstanding quality of the S&P 500 as well as for a potential for MSCI to catch up - provided that the company continues its successful operating performance in terms of sales, earnings and cash flow.
Do you have MSCI in your portfolio? Are you thinking about buying the stock?
