Suggestion of the Month : deep dive into OTC Market Group

Saddle up for a wild ride through the world of OTC Markets Group, where the stocks are a little quirky and the profits might just surprise you.

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This week we’re diving into one of your suggestions OTC market group, the pretty much sole player in the OTC market.

OTC Markets Group: A Deep Dive into the Wild West of Wall Street

OTC Markets Group is like the vibrant, bustling marketplace for stocks that don't quite fit on the main stage. Think of it as the "island of misfit toys" for stocks, but instead of being unwanted, they're just a little... different. Maybe they have a quirky sense of humor, or they prefer wearing mismatched socks.

They operate regulated markets for trading over 12,000 U.S. and international securities. These are the companies that prefer a more relaxed regulatory environment than the big exchanges like the NYSE or Nasdaq. Maybe they find all those rules a bit stifling, like being forced to wear a tie to a pool party. They've got three public markets: OTCQX® Best Market (the established, well-behaved companies - the ones who always remember to say "please" and "thank you"), OTCQB® Venture Market (the up-and-comers with potential - the ones who might be a little rough around the edges, but have a good heart), and Pink® Open Market (the more speculative, wild-west scene, where you might find a company that's trying to sell you a time machine...or a bridge).

But they're not just about listing companies. They also provide the crucial technology that makes trading happen smoothly. Their OTC Link® Alternative Trading Systems (ATSs) are the invisible gears and cogs that connect brokers and dealers, ensuring trades are executed efficiently. It's like the plumbing of the OTC market - you don't see it, but you definitely want it to work properly! (Nobody wants a stock market leak, that's for sure).

Show Me the Money! : How OTC Markets Group Fills its Saddlebags

OTC Markets Group has a diversified revenue model, kind of like a skilled entrepreneur with multiple income streams (or someone who's really good at juggling... while riding a unicycle and playing the accordion):

• OTC Link The Trading Saloon Where Everybody Knows Your Name: This is their core trading service. They provide a platform called OTC Link ATS where broker-dealers can trade securities. Broker-dealers pay monthly subscription and connectivity fees to access OTC Link ATS. Think of it as a members-only club where brokers pay a monthly fee to access the facilities and trade with each other. They also have usage-based fees for publishing quotes and delivering trade messages. This is like charging extra for premium services within the club, such as personalized trading advice ("Buy low, sell high! Just kidding, I have no idea.") or access to exclusive events (like a "how to make a killing in penny stocks" seminar... led by a guy wearing a fake mustache and a monocle).

• Market Data Licensing They've Got the Goods and the Data on All the Stocks: They're like the information brokers of the securities world. They collect a ton of data on securities and issuers, organize it, and sell it to those who need it - investors, analysts, media outlets, etc. They offer different types of data licenses, from real-time to delayed to end-of-day, and they even have a "security master" with detailed issuer information. It's like having a library of financial knowledge and charging people a subscription fee to access it. But instead of dusty old books, they have shiny computer screens... and probably a coffee machine that makes lattes (with oat milk, of course).

• Corporate Services Helping Companies Go Public : They're the ones who help companies get their securities traded on their markets. They operate the OTCQX and OTCQB markets, which have different levels of requirements and prestige. Companies pay application fees and annual or semi-annual fees to be included in these markets. They also offer additional services like news dissemination and investor conferences. Think of it as a concierge service for companies, helping them navigate the complexities of the financial markets and connect with investors. They're like the "Fairy Godmother" of the OTC market, except instead of turning pumpkins into carriages, they turn obscure companies into publicly traded entities (and maybe give them a little pep talk: "You got this! Go make millions!").

Who's Hanging Out in This Town? : OTC Markets Group's Clientele

OTC Markets Group has a diverse clientele, including:

• Broker-dealers: These are firms like Charles Schwab or TD Ameritrade, who execute trades for their clients.

• Investors: This includes everyone from individual investors like you and me to large institutional investors like BlackRock or Fidelity.

• Traders: These are the professionals who buy and sell securities for a living, trying to make a profit from market fluctuations. They're the ones who watch those stock tickers like hawks, fueled by caffeine and the dream of owning a yacht someday.

• Institutions: This category includes banks, hedge funds, pension funds, and other financial institutions that invest in securities.

• Companies: These are public companies that want their securities traded on OTC Markets Group's markets. For example, Nintendo is listed on the OTCQX market. (Yes, that Nintendo! Apparently, they like to dabble in the OTC market... maybe they're looking for the next big Pokémon).

• Accountants: These are the financial professionals who help companies with their financial reporting and compliance.

• Regulators: This includes government agencies like the SEC, who oversee the markets to ensure fairness and transparency. They're like the referees of the financial world, making sure everyone plays by the rules... and doesn't try to sneak in any illegal tackles.

The Showdown: OTC Markets Group vs. the Big Guns (Nasdaq and NYSE) And Why This Town Ain't Big Enough for the Both of 'Em

The financial markets are a competitive arena, with major players like Nasdaq and NYSE dominating the scene. But OTC Markets Group has carved out a successful niche, focusing on companies that don't fit the mold of the big exchanges. They're like the independent coffee shop that thrives despite being surrounded by Starbucks, offering a cozier atmosphere and maybe even a better latte. They also face competition from other market data providers, but their unique data sets give them a competitive edge. It's like having the only map to a hidden treasure chest... filled with valuable stock tips (and maybe a few chocolate coins).

But here's the catch: the biggest problem for the OTC market is a bit like a Wild West town where the most successful folks eventually pack up and head for the big city. When a company listed on the OTC market strikes gold and becomes really successful, they often mosey on over to the NYSE or Nasdaq. There are a variety of reasons for this:

• Increased visibility and liquidity: The NYSE and Nasdaq are like the bustling metropolises of the stock market world, offering more exposure and easier trading. It's like moving your store from a quiet side street to the main square.

• Cost-cutting and investor focus: Sometimes, a company might be listed on several exchanges around the world. To save money and focus on their biggest investors, they might decide to delist from some of the smaller exchanges, like a gunslinger deciding to lighten their load before a duel.

• Involuntary departures: In some cases, companies are forced to move to a different exchange if they no longer meet the financial or regulatory requirements of their current exchange. It's like being kicked out of the saloon for being a little too rowdy.

This "graduation" of successful companies to the bigger exchanges can be a challenge for OTC Markets Group, as it limits their ability to grow and retain the most valuable companies. It's like a talent show where the best singers always get snatched up by big record labels.

Slicker Than a Saloon Door: OTC Markets Group's Operational Efficiency

OTC Markets Group is a model of operational efficiency. They've got a gross margin of around 60% and an operating margin of 30%, demonstrating their ability to control costs and generate profits. Their free cash flow margin is also around 30%, highlighting their strong cash generation capabilities. They're like the financial version of a well-oiled machine... or a perfectly baked soufflé.

Giddy Up! But Not Too Fast: Analyzing OTC Markets Group's Growth

Operating cash flow has grown at an average of 10% per year over the last 5 years. But hold your horses! This growth hasn't exactly been a smooth ride. They had a bit of a slump for a few years, then BAM! 2020 saw 20% growth, and 2021 went bonkers with 80% growth. You know, that crazy time when everyone and their grandma was trading on the Pink market during the COVID boom. That kind of rollercoaster growth raises a bit of a red flag for us - we prefer the slow and steady kind. It's like trying to ride a bull... that's also on a trampoline.

Blazing a Trail: OTC Markets Group's Plans for the Future

OTC Markets Group has a clear vision for the future. They want to:

• Expand their OTC Link platform to attract a wider network of broker-dealers. (Maybe they'll offer free donuts on Fridays?)

• Increase the number of companies listed on their OTCQX and OTCQB markets. They could put up billboards: "Tired of those pesky NYSE rules? Come on over to the OTCQX!"

• Enhance their market data offerings to meet the evolving needs of their subscribers. (They could offer a "psychic stock predictions" add-on... though we wouldn't recommend relying on it).

• Continue investing in their technology to maintain a competitive edge.

Counting the Gold Nuggets: OTC Markets Group's Valuation

• Valuation (as of December 31, 2024)

  • Market Cap: $607 million

  • EPS: $2.35

  • Free Cash Flow: $30.7 million

  • Dividend per share: $2.22

  • P/E Ratio 21.6x

  • Price to Free Cash Flow 19.8x

  • Free Cash Flow Yield 5.1% > 4.6% (10-Year Treasury Yield)

Digging Deeper: Growth Analysis (and Why We're a Little Skeptical)

To achieve our desired 15% return, the EPS needs to grow between 12% and 20% for 5 years, with a final P/E between 15 and 22. However, it's unclear if OTC Markets Group can hit that 12% growth target. They're the main player in their niche market, and let's face it, the OTC market isn't exactly the hottest ticket in town. It's like being the biggest fish... in a very small pond. Most of their recent growth has come from market data licensing, not transaction fees, which indicates that their core trading business might not be expanding as rapidly as we'd like. It's like a bakery making more money from selling cookbooks than from selling actual cakes.

Considering their 10% average growth in net income and operating cash flow over the past 5 years (with that one crazy 80% growth spurt in 2021), it seems unlikely that they'll consistently achieve the growth needed to meet our investment goals. It's like hoping your pet turtle will suddenly win the Indy 500.

A Fistful of Dollars: What's Up with OTC Markets Group's Capital Allocation?

OTC Markets Group has a unique approach to capital allocation. They prioritize returning value to shareholders, which is not at all evident in their high return on invested capital (ROIC) of around 40% over the past five years. However, it's important to note that they don't reinvest a significant portion of their profits, in fact the reinvest pretty much nothing which could inflate the ROIC. It's like someone bragging about their amazing gas mileage... because they only drive to the end of the block and back.

They generate about $30 million in free cash flow, and almost all of it goes back to shareholders through dividends ($9 million + $17 million special dividend) and share buybacks ($4 million). This strategy might not appeal to growth-focused investors, but it's beneficial for those seeking steady income. It's like choosing between a dividend-paying stock... and a lottery ticket that might just make you a millionaire (or might just be a piece of paper).

The Sheriff's a Little Too Much in Charge: Ownership and Capital Allocation at OTC Markets Group

Nearly half of the company is owned by insiders, and over a third is held by the CEO himself, Robert Cromwell Coulson. Now, usually, we love to see this kind of insider ownership. It shows that management has skin in the game and their interests are aligned with those of other shareholders. It's like knowing the sheriff is also the biggest landowner in town - he's got a vested interest in keeping things safe and prosperous.

But in this case, the concentration of ownership might be a tad high for our liking. It raises some concerns about liquidity and capital allocation. With so much stock in the hands of insiders, it can make trading a bit more difficult, like trying to find a dance partner in a saloon where everyone's already paired up.

And speaking of capital allocation, it seems like Mr. Coulson might be a bit too eager to line his own pockets. The company is dishing out a hefty chunk of its free cash flow in the form of dividends (including a special dividend), and a good portion of that is going straight to the CEO. Now, we can't blame the guy. He's worked like a dog to build this company, and maybe now he's ready to trade in his saddle for a hammock and a margarita. But from an investor's perspective, we'd prefer to see more of that cash flow reinvested in the business to fuel future growth. It's like the sheriff deciding to spend all the town's tax revenue on a gold-plated bathtub instead of fixing the leaky roof on the jailhouse.

So, while we appreciate Mr. Coulson's entrepreneurial spirit and dedication, this level of insider ownership and the current capital allocation strategy gives us a bit of pause. It's like a poker game where the dealer is also the biggest player at the table - you can still play, but you might want to keep a close eye on your chips.

Our Take: A Solid Business, But Not Our Cup of Tea Or Should We Say, Not Our Shot of Whiskey?

Alright, let's have a little heart-to-heart about OTC Markets Group. These guys have built an incredibly solid business. They've got a wide moat, like a fortress surrounded by a raging river, because they're pretty much the only game in town when it comes to the OTC market. Sure, they have some competition from the NYSE and Nasdaq, but it's not a head-to-head showdown. It's more like... they're the talent scouts, and the big exchanges are the record labels. OTC Markets Group finds the promising up-and-comers, and when those companies hit the big time, they often "graduate" to the bigger leagues.

And that's where our main concern lies. They're stuck in this position of nurturing talent but ultimately seeing it walk out the door. It's like being a proud parent watching your kids grow up and move out – you're happy for them, but it can be a little bittersweet.

Now, let's talk about that capital allocation strategy. It seems like CEO Robert Cromwell Coulson has built himself a real cash machine with OTC Markets Group. The company is generating so much free cash flow that they're practically drowning in it, like Scrooge McDuck swimming in his vault of gold coins. And what do you do when you've got more money than you know what to do with? You give it back to the shareholders!

That's exactly what they're doing, dishing out a hefty chunk of its free cash flow in the form of dividends (including a special dividend). And a good portion of that is going straight to the CEO, which, let's be honest, is totally understandable. The guy's worked his tail off to build this company, and now he's probably thinking, "Time to kick back and enjoy the fruits of my labor!" We're not saying it's a bad strategy. Heck, they wouldn't be where they are today if they were making terrible financial decisions.

But it's just not what we're looking for in an investment. We'd still prefer to see more of that cash flow reinvested in the business to fuel future growth. It's like the sheriff deciding to spend all the town's tax revenue on a solid gold statue of himself instead of, you know, building a new schoolhouse or something.

We're not here for a 4% dividend yield. We're looking for that million-dollar portfolio that keeps growing and growing, like a tumbleweed rolling across the prairie, picking up more and more stocks along the way.

So, while we admire OTC Markets Group's business model and their dominance in the OTC market, this one's a pass for us. It's a solid company, but it doesn't quite fit our investment strategy. We're tipping our hats and moving on to the next town, hoping to find a company that's a little more... growth-oriented.

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