, Is CME Group Stock Fairly Priced?, The Nzuchi News Forbes

Is CME Group Stock Fairly Priced?

CME Group stock (NASDAQ: CME), the world’s largest financial derivatives exchange, gained roughly 18% – increasing from about $182 at the beginning of 2021 to around $216 currently, outperforming the S&P500, which grew 12% over the same period. The exchange has surpassed the consensus estimates over the last two quarters, mainly driven by strong ADV (average daily volume) growth on a sequential basis. This has led to positive investor interest in the stock.

There were two main reasons behind the rise in ADV on a sequential basis: First, the approval of the $1.9 trillion stimulus package. Second, the increase in retail investor participation.

But is this all there is to the story?

Not quite, despite the recent gains, Trefis estimates CME Group’s valuation to be around $212 per share – slightly below the current market price, based on a key opportunity and one risk factor.

The opportunity we see is an improved trajectory for CME Group’s revenues over the subsequent quarters. The company reported $4.9 billion in revenues for the full year 2020, which is marginally ahead of the 2019 figure. The growth was restricted due to a slight drop in the clearing and transaction fees, which constitutes more than 80% of its revenues. The clearing & transaction fees for CME suffered in 2020, unlike its peer NASDAQ, because of lower contract volumes on a year-on-year basis driven by lower ADV in interest rate contracts. Additionally, its average rate per contract also saw a slight dip in the year.

The exchange posted better than expected results in the first quarter of FY2021. CME reported total net revenues of $1.25 billion, which is 18% less than the year-ago period. This could mainly be attributed to a 21% drop in clearing and transaction fees. While the ADV increased on a sequential basis, it dropped on a year-on-year basis – ADV in the first quarter decreased 19% y-o-y. The decline was a result of lower volatility as compared to the first quarter of 2020, as economic uncertainty regarding government policy and its impacts has declined. That said, trading volumes are expected to normalize with recovery in the economic conditions. But it is likely to take some time. Overall, we expect the CME revenues to touch $5.1 billion in FY2021 – 4% ahead of the 2020 figure.

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The adjusted net income margin is likely to see some improvement in FY2021 from 43.1% to 49.1%. As a result, the company’s net income is likely to grow 18% y-o-y to $2.5 billion, leading to an EPS of $6.94. The EPS of $6.94, coupled with the P/E multiple of just below 31x will lead to a valuation of around $212.

, Is CME Group Stock Fairly Priced?, The Nzuchi News Forbes

Finally, how much should the market pay per dollar of CME Group’s earnings? Well, to earn close to $6.94 per year from a bank, you’d have to deposit about $694 in a savings account today, so about 100x the desired earnings. At CME’s current share price of roughly $216, we are talking about a P/E multiple of close to 31x. And we think a figure around that amount will be appropriate.

That said, a financial exchange is still a risky proposition. While growth is likely, change in current market sentiment can harm the near-term outlook. What’s behind that?

CME is heavily dependent on clearing & transaction fees, which, in turn, depends on ADV. The ADV benefited from higher retail investor participation over the recent quarters. While retail investor participation has significantly increased, it is also to be noted that they don’t have much loss-taking capacity. Hence, an unexpected course correction in the market can result in substantial losses for them, pushing them out of business, and hurting the trading volumes. To sum things up, we believe that CME Group stock is slightly overvalued.

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