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Exchange stocks have recently emerged as a raging bull market on Jim Cramer's radar. And it seemingly appeared out of nowhere.
"The exchange stocks are experiencing a renaissance on Wall Street, thanks to a huge wave of consolidation that has wiped out so much of the competition. And in this environment, I think the group can keep moving higher," the "Mad Money" host said.
In addition to operating well-known stock and futures markets, many exchange plays provide data and technology services for institutional investors around the world.
Exchange stocks have pulled back from their highs recently, which led to Cramer highlighting them as a possible buy on weakness. However, exchange operators have performed better than the stock markets that they actually run.
In particular, Cramer liked three exchange plays. First was the CME Group, which owns the Chicago Mercantile Exchange. He also liked Intercontinental Exchange, which is a futures trading play that bought the New York Stock Exchange three years ago in the NYSE-Euronext acquisition, followed by Nasdaq, Inc.
In the past two years, CME has risen 41 percent, Nasdaq has climbed more than 60 percent and Intercontinental Exchange has climbed 38 percent. Meanwhile, the has rallied approximately 10 percent in the same time period.
"When I saw the action in this group, I was surprised. I mean, how the heck have these exchange stocks been able to so consistently outperform the broader averages?" Cramer asked.
It all came down to consolidation, Cramer said. About four years ago there was a major wave of acquisitions among exchange companies. Prior to the consolidations, the group was torn apart by fierce competition, with too many exchanges competing for the same volume.
However, with new financial regulations, it became more efficient for the exchanges to merge and centralize back-office functions.
So how do investors play the boom of the exchange business?
Cramer recommended both Intercontinental Exchange and Nasdaq over CME because of their diversification. CME is a hostage to trading volumes, Cramer said.
Nasdaq is the most diversified, as it received only 43 percent of its revenue from transaction fees, which is the core of an exchange's business. It increasingly makes money from providing information, technology and licensing its names to various indices and ETFs.
Intercontinental Exchange has also made a move towards diversification by becoming more of a technology and information play. It acquired IDC, which sells pricing data to more than 5,000 customers, for $5.2 billion.
CME on the other hand has not focused on buying innovation or growth. It simply doubled down on what it is, which is why 83 percent of its revenue came from transaction fees last year. That is much higher than the group average of 67 percent. However, CME does offer a wide range of products, which Cramer said meant that it tends to do well when the market becomes volatile.
"Given the newfound scarcity value of these exchanges, I would be inclined to buy any of the three, betting that if they can make this much money when the volume is this low, who knows what they can do if more investors ever return to their platforms," Cramer said.