Introduction
What's a wealth compounder?
According to Morgan Stanley, it's a very specific kind of stock with tremendous return potential.
Our research shows that these ”compounders,” which exhibit characteristics such as strong franchise durability, high cash flow generation, low capital intensity and minimal financial leverage, have generated superior risk-adjusted returns across the economic cycle. - Morgan Stanley (emphasis added)
Generally speaking, we're all looking for wealth compounders - stocks that give us the power of compounding interest, like the exponential curve below.
While strategies and financial requirements differ (some investors require higher income, while others cannot stomach cyclical risks), it's all about finding investments that grow our wealth above the rate of inflation and potentially come with rising dividends.
That's where MSCI Inc. (NYSE:MSCI) comes in, a financial powerhouse I started covering in 2022.
This wide-moat S&P 500 member has been one of the best compounders in recent history, returning 19.5% per year since November 2007, when it spun off from its former parent Morgan Stanley (MS).
Bear in mind that MSCI stands for "Morgan Stanley Capital International."
To give you an idea of how big of a deal a 19.5% annual return is, an initial investment of $10,000 after the spin-off would have turned into $219,750.
That's above the current median price of a home in Oklahoma.
Obviously, past returns are meaningless for future returns.
If you buy now, it's irrelevant how much money investors before you made.
With that said, after my most recent article was published on September 13, 2023, it's time to revisit the bull case as the stock has gone sideways since 2021, pressured by last month's earnings release.
So, let's get to it!
The Wide-Moat Behind MSCI
MSCI is a financial giant. However, in an industry dominated by banks, it offers very specific services.
Essentially, the company aims to help investors navigate the many complexities that come with global markets, including leveraging its knowledge of global investment processes, research, data, technology, and portfolio construction.
Its product portfolio consists of a number of services that all benefit from strong (secular) demand growth.
- Indexes: The company covers global equity, fixed income, ESG, and specific thematic investments through its indexes. Using the data below, we see that MSCI benchmarks cover $15.6 trillion in assets!
- Portfolio Construction and Risk Management Tools: The company offers advanced risk and performance analytics.
- ESG and Climate Solutions: MSCI provides insights and tools for integrating sustainability into investment processes.
- Private Asset Data and Analysis: The company helps to deliver transparency and insights into private market investments.
Going into this year, the company had close to 7,000 clients in more than 95 nations, with BlackRock (BLK) being its largest client, accounting for roughly 10% of its operating revenue.
BlackRock's revenues are mainly generated through asset-based fees on its ETFs and non-ETF products that use MSCI indexes.
For example, the one below:
Essentially, MSCI is one of the biggest winners of the global surge in passive investing through ETFs and similar products.
In general, the company believes it has at least four major tailwinds supporting long-term growth:
- Rapidly evolving client operating models and business strategies.
- The adoption of multi-asset-class and private asset investments.
- The ongoing integration of ESG and climate-based guidelines.
- Growth of indexed investing and demand for high-quality data.
Although the dependence on BlackRock may be a risk, the company has a wide-moat business model benefitting from a massive footprint in the index business, as it has benchmarks that have become cornerstones of the financial industry, including the MSCI ACWI Index and the MSCI Emerging Markets Index.
In addition to increasing interest in passive ETF investing, investors need benchmarks to compare their performance - often using unique benchmarks for specific purposes.
Moreover, regardless of what someone's opinion is on ESG investing (I'm very critical of it), the company uses so many indicators and has such a good reputation/strong relationships that it's very hard for competitors to take market share.
The MSCI Dividend
With regard to the total return, the company's business has supported aggressive dividend growth.
After hiking its dividend by 16% in January, it currently pays $1.60 per share per quarter. This translates to a yield of 1.3%.
Although a 1.3% yield is nothing to write home about, we need to keep a few things in mind.
- The dividend comes with a payout ratio in the low-40% range.
- The dividend has a five-year CAGR of 20.8%!
- The dividend has been hiked every year since the dividend was initiated.
In other words, the only reason why MSCI is not a high-yield stock is because the market always made sure that dividend growth was offset by capital gains.
That's not a bad thing, except if you require elevated income. In that case, MSCI is likely the wrong stock for you.
The Fuel Behind 20% Annual Returns
A strong business model has translated to fantastic growth rates.
Using the data below, we see the company has compounded its revenue by 13% per year since 2019.
Thanks to higher margins (it has adjusted EBITDA margins in the high 50% range), it was able to compound adjusted EPS by 20% per year since 2019.
To maintain elevated growth, the company uses its market leadership to improve innovation and cater to evolving client needs.
For example, during this month's Barclays Americas Select Franchise Conference, the company noted it is accelerating new product development across its segments, including AI-driven analytics.
This is bearing fruit.
Since 2018, the number of clients using multiple MSCI products has risen substantially, with 77% using three or more products (up from 69%).
Moreover, average client spending has risen significantly.
Growth measures are also focused on ESG and climate solutions.
While global political shifts could be a headwind for ESG standard adoption, the company sees strong demand for its solutions, with climate-related products accounting for almost 20% of the company's total ESG run rate, with 40% growth.
Especially in Europe, demand for its solutions is strong.
In addition to that, MSCI is diversifying into the private asset market.
This includes the takeover of Burgiss, which has boosted MSCI's capabilities in providing private market portfolio coverage - mainly dealing with institutional investors and asset owners.
With over 35 years of expertise in alternative investments, Burgiss offers private asset data, analytics, and software applications, including leading research-quality performance data that dates back to 1978. The Burgiss dataset covers over 13,000 private asset funds around the world, representing $15 trillion in cumulative investments across private equity, private real estate, private debt, infrastructure, and natural resources in 195 countries. - MSCI
So, what does this mean for shareholders?
How Much Shareholder Value Is Left?
Despite returning 20% annually since its spin-off, the company has gone sideways since 2021. It is currently 27% below its all-time high and down 13% year-to-date.
This is partially to blame on its 1Q24 earnings report, although MSCI shares have recovered substantially since then.
Essentially, in 1Q24, the company reported 10% organic revenue growth, 12% higher adjusted EPS, and a 14% higher free cash flow.
While these numbers aren't bad, they were lower than expected, pressured by weak recurring sales (new recurring sales were flat on a year-over-year basis).
In general, the industry is being pressured by market volatility, interest rate uncertainty, and pressure on investment firms - especially active managers.
This included a significant $7 million cancellation from a major client, which is related to the merger of two major banks in Europe (we can assume that's Credit Suisse and UBS).
Readers who frequently read my articles know that I'm worried about inflation and interest rates as well.
As bullish as I am on the future of MSCI, this is not a great environment for the "average" investor, especially those investing in ETFs.
While I do not expect that MSCI will run into trouble, it could likely see "subdued" growth rates, which could keep a lid on its share price.
Using the FactSet data in the chart below, MSCI is currently trading at a blended P/E ratio of 35.2x.
- The company's normalized P/E ratio going back to its spin-off is 30.0x, which means it trades at a premium.
- Analysts expect the company's annual EPS growth to average 12% in 2024-2026.
I believe these growth rates are too low to justify a 37x earnings multiple.
I would even make the case that a 30x multiple requires higher growth rates.
That said, I stick to my Buy rating.
Even if we use a 30x multiple, the company has a fair stock price of $567 using 2026E EPS of $18.89. This implies 15% upside.
With all of this in mind, investors who believe MSCI is right for their portfolios may be better off buying gradually. If the economy remains in a tough spot, we could see some more downside, allowing investors to average down.
However, given MSCI's growth potential, every bit of good news will likely lead to a higher share price.
Depending on one's strategy and time horizon, I think MSCI makes for a great long-term investment. It's just a bit tricky to deal with the short-term valuation.
Takeaway
MSCI is a perfect example of a wealth compounder, returning 20% annually since its spin-off.
As a financial powerhouse focused on global market services, MSCI capitalizes on diverse revenue streams, from index services to ESG solutions and private asset data analysis.
While recent market volatility and macroeconomic challenges may have turned into headwinds, MSCI's strong fundamentals and growth initiatives signal a promising growth outlook - just lower compared to prior years.
With advanced investment strategies and an eye on long-term value, MSCI remains a compelling choice for investors seeking sustained wealth accumulation.
However, investors need to keep an eye on its valuation, as short-term returns may be underwhelming if headwinds remain strong.
Pros & Cons
Pros:
- Consistent Growth: MSCI has an impressive track record of 19.5% annual returns since its spin-off. While this is no guarantee of future returns, the company has found a great way to grow.
- Diverse Revenue Streams: From index services to ESG solutions, MSCI's diversified portfolio comes with a wide range of unique capabilities.
- Market Leadership: With benchmarks covering $15.6 trillion in assets, MSCI's dominance comes with wide-wide characteristics.
- Dividend Growth: The dividend comes with a five-year CAGR of 20.8%, with the likelihood of prolonged double-digit growth.
Cons:
- Market Volatility: Recent volatility and macroeconomic headwinds pressure revenue growth.
- Client Dependency: While the relationship with BlackRock is lucrative, this reliance could come with headwinds in the future.
- Valuation Concerns: Trading at a premium with a P/E ratio of 35.2x, MSCI faces challenges in justifying its valuation, which means the room for error is small.
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