The securities market operator segment of the stock exchange is small but vibrant. One of the top companies in this little club is CME Group (NASDAQ:CME).
Earlier this year, I dived into the operations and the stock appreciation prospects of CME Group's rival, Cboe Global Markets (NYSEMKT:CBOE). Now it's CME Group's turn; here's my two cents on whether it's a worthwhile investment these days.
A good trade
CME Group's concentration is markets that facilitate futures and options trading. Its operations comprise four component securities markets:
CME -- The core asset, a futures and options powerhouse. Other asset classes such as equities and foreign-exchange products can also be traded here.
CBOT -- This stands for Chicago Board of Trade, which, in CME Group's words, specializes in "agricultural, equities, energy and interest rate products."
NYMEX -- New York Mercantile Exchange, an exchange for metals and energy securities.
COMEX -- Commodity Exchange, a metals trading market.
Since CME Group as a whole is an owner of securities markets, it makes the bulk of its money on clearing and transaction fees. In 2018, these were responsible for 85% of the company's $4.3 billion in revenue; 10% of that total came from market data and information services; and the remainder fell into the "other" category.
Last year was a great year to be an exchange operator. That's because such companies thrive on volume, since they get a little piece of every transaction made on their markets. Securities trading was volatile last year (read: busy), so as a whole the peer group housing CME Group and Cboe Global Markets did very well.
CME Group saw its revenue rise by 18% on a year-over-year basis in 2018 to the aforementioned $4.3 billion. Due to the impact of tax reforms that impacted 2017 results, 2018's net profit dropped steeply to just under $2 billion -- a more than 50% drop from the previous year.
Probably a better line item to gauge performance is pre-tax income, which was up 10% to nearly $2.8 billion.
The rich man in the middle
CME Group has historically been very profitable, since it's essentially a big and sprawling middleman business. Potential investors shouldn't worry about the company's moneymaking prowess; as long as most of its markets have at least something of a pulse, CME Group should earn a buck. We can say the same for Cboe Global Markets and the rest.
Whether you're willing to buy CME Group now depends on whether you're a bull or bear regarding future market volume. If you feel that futures and derivatives markets will remain vibrant, or even intensify, the stock is a compelling potential purchase.
Analysts seem cautiously optimistic about the proximate future. Although they're collectively estimating only marginal per-share net profit growth this year, from 2019 to 2020 they believe this will rise by a respectable 10%. Revenue's a bit of a different story; those prognosticators think it will increase by 15% this year and 6% next.
Meanwhile, the stock is priced at a forward price-to-earnings ratio of 23 and change, suggesting it's currently overvalued (generally, a stock is considered fairly priced if expected growth is more or less in line with forward P/E)..
That said, there's another consideration here -- the dividends. CME Group pays a not-especially high quarterly distribution of $0.75 per share. But the real meat on that bone is the annual variable dividend, a fiscal-year-end payout started in 2012 that depends on operational and other results.
The 2018 edition (paid in January 2019) was $1.75 per share, which adds nicely to the company's overall dividend yield (2.6%, if we annualize the current regular dividend and mix in the annual variable). This once-a-year special, however, has been higher in the past -- for 2017 it was $3.50 per share, and in 2016 it was $3.25.
Still, even at the reduced rate, the annual variable dividend gives the company a nice overall yield figure. I like that, and since I'm more bullish than most analysts about the future of securities markets, I like CME Group in general. This stock would be a buy for me.