In a declining market, oftentimes the highest quality companies still command high multiples due to their competitive position in their respective markets. When a company has some sort of competitive advantage, such as being the first mover in a market with high barriers to entry, it will often retain a premium multiple.
Here are two such companies that are either part of a duopoly or have monopolies on certain important products. These companies may cheapen at times but rarely become "cheap." Let's find out a bit more about these two hot stocks that live up to their lofty valuations.
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1. American Tower
American Tower (AMT 0.17%) is a cell phone real estate investment trust (REIT) that operates in a duopoly with Crown Castle International. Cell phone tower REITs have an incredibly stable business model and are benefiting from a long-term trend of increasing usage of mobile data. The company builds cell phone towers and then leases out capacity to wireless service providers, TV and radio broadcasters, as well as government tenants.
American Tower's business is characterized by substantial barriers to entry. While it has other smaller competitors, the two heavyweights dominate the industry and own all the best tower locations. American Tower owns over 200,000 towers worldwide and is truly a global player.
Global data usage has been climbing as cell phones become more data-driven. According to one study, the typical user consumed 15 gigabytes of data monthly at the end of 2021. This is forecasted to increase to 52 gigabytes monthly by the end of 2027, which works out to be a cumulative average growth rate of 24%.
American Tower is guiding for 2022 adjusted funds from operations (AFFO) to come in around $9.72 per share. REITs generally use funds from operations as a way to describe earnings since depreciation and amortization are such big factors in earnings per share. Depreciation and amortization are non-cash charges, which means this is more of an accounting issue than a cash flow issue. At current levels, the stock is trading at 26 times 2022 guided AFFO per share, which is pricey for a REIT but worth it for a market leader. One other thing worth noting: American Tower has hiked its dividend every single quarter since 2012.
2. CME Group
CME Group (CME -0.43%) is one of the biggest derivatives exchanges in the world. Its portfolio includes the Chicago Mercantile Exchange, the Chicago Board of Trade, the New York Mercantile Exchange, and several other platforms. CME Group is best known for its dominance in interest rate derivatives. Companies generally use interest rate derivatives to hedge cash flow streams and to lock in borrowing costs or lending returns. Companies often trade in the foreign exchange market and use derivatives to hedge costs and revenues in other countries.
CME Group struggled during the COVID-19 pandemic as the Federal Reserve cut interest rates to the floor in order to stimulate the economy. Since interest rates generally can't go below zero, commercial traders won't bother to hedge against that risk. This caused trading volumes in its flagship interest rate products to decline. That said, the Fed is now aggressively raising interest rates to fight inflation, which will stimulate more trading volume. In the first quarter of 2022, average daily volumes in interest rate products rose 21% on a year-over-year basis.
CME Group is trading at 26.6 times expected 2022 earnings per share. Given how multiples have contracted since the beginning of the year, this may appear to be a pricey multiple, but CME Group is one of the few companies that will benefit from rising interest rates. Given CME's franchise value and the massive barriers to entry for new exchanges, it warrants a premium multiple.
