usd and usd: Don't Gamble, Own the Casino Instead

Friday, March 29, 2013

Don't Gamble, Own the Casino Instead

"Gamblers always die broke, young man," whispered the grizzled, old casino lizard at the Blackjack table as I gathered my meager winnings.

It wasn't very nice to hear: A recent college graduate, I had just earned a small sum during my first visit to a casino. But that advice ended up being among the wisest and most foresightful I have ever heard.

Soon after I met the old man, I read comments from billionaire casino owner Steve Wynn: "The only way to win in the casino is to own one." His words still resonate with me.

I thought to myself "Money lessons come from the most unexpected places." Here was a successful casino owner and a hard-core gambler essentially giving the same advice -- don't gamble and remember that the only way to win is to own the casino. I have never had interest in casino games since.

Anytime I feel the urge to gamble in the financial markets or casinos, my mind returns to the old gambler's advice. Just picturing that man's face and thinking about how much he may have lost during his lifetime is enough to squelch any lingering gambling desire.

But I have a strong attraction to commodities and derivatives. Combining the idea of owning the casino with my interest in commodities led me to what I consider the greatest casino in the world: the Chicago Mercantile Exchange (CME).

While not a casino in the traditional sense, a tremendous amount of betting and gambling goes on within its jurisdiction.

Founded in 1898, the CME has grown to become the world's largest futures exchange. After a 2007 merger with the Chicago Board of Trade, the CME Group (Nasdaq: CME) was formed.

The CME now trades several types of financial instruments such as interest rates, equities, currencies and commodities. It also handles alternative investments such as real estate and weather derivatives. There are more options and future contracts traded on the CME than any other exchange in the world.

So how is the CME Group looking as an investment right now? Is it time to "own the casino?" Here's a closer look...

The company is building on 5-year annual revenue growth of 10.7%. However, revenue dropped in 2012 by more than 11% to $2.9 billion. This is due to the competition formed from the Intercontinental/New York Stock Exchange merger and the 2011 collapse of MF Global Holdings, a futures broker involved in a trading scandal.

But I think these issues will soon work out as traders slowly feel more secure. The gross margins of the CME Group are a mind-blowing 97% and net margins are respectable at nearly 31%. The balance sheet looks solid with a debt-to-equity ratio of just above 13%. The stock is currently yielding 3% with 5-year dividend growth of 21%.

Other than recent slowed revenue growth, I like the fundamental numbers and technical picture. Shares have soared about 26% this year, recently climbing past $63. However, the stock has since fallen back, setting up an ideal buying opportunity.

Risks to Consider: Greater competition and the fallout from the MF Global scandal have hurt the CME Group. But I think revenue will soon return to normal growth. There is a tremendous amount of money on the sidelines waiting to get back into the market, and when it does, the CME Group will benefit. However, no one knows the future.

Action to Take -- The CME Group is an ideal opportunity "to own the casino." This casino actually serves a real economic purpose for farmers and other producers who use it to manage market risks. I like the stock as a "buy" right now with a stop-loss at $59 and an 18-month target price of $70.

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David Goodboy