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CME Group Inc (CME), NYSE Euronext (NYX), NASDAQ OMX Group, Inc. (NDAQ): This Exchange Has a Bright Future, But Expensive Shares

CME Group IncCME Group Inc (NASDAQ:CME) is the largest futures exchange in the world, providing exchange-traded derivative contracts on interest rates, stock indexes, foreign exchange, energy, commodities, and real estate. The company has done extremely well recently, with shares up almost 25% in the past three months, although revenues have been somewhat inconsistent in recent years. CME Group Inc (NASDAQ:CME) is set to report their second quarter earnings on Thursday, August 1, and I wanted to take a closer look at this company. Specifically, with single-digit growth expected in the years ahead, why is CME Group Inc (NASDAQ:CME) trading at such a high earnings multiple? Also, would one of the other publicly-traded exchanges be a better addition to our portfolio?

A bit about CME

CME Group has been called “The biggest financial exchange you have never heard of” by The Economist due to its products that are not very well known to most casual investors (when is the last time you traded derivatives that were based on interest rates?). However, CME has been incredibly successful at growing its business, and now trades at a larger market capitalization than NYSE Euronext (NYSE:NYX) and NASDAQ OMX Group, Inc. (NASDAQ:NDAQ) combined.

The company operates its own clearing house, which allows it to doubly benefit from its trades, capturing fees related to both the trading and clearing of its derivative products. CME Group Inc (NASDAQ:CME) makes most of its revenue (81%) from these fees, with the rest coming from their open outcry auction markets, privately cleared transactions, and CME ClearPort OTC, which provides clearing services for OTC transactions.

One of CME Group Inc (NASDAQ:CME)’s strategies is to become the leader in various niche markets, which is evidenced by the company’s announced intent to buy the Kansas City Board of Trade, the dominant venue for selling hard red winter wheat.

High valuation…why?

CME’s revenue increased from 2008-2011, but fell 11% in 2012. Over the next couple of years, most analysts project revenue growth in the mid-single digits. This begs the question of why shares are so expensive. At the current price, CME Group Inc (NASDAQ:CME) trades for 28.3 time trailing earnings. However, CME is expected to produce very nice earnings growth due to the combination of modestly increasing revenues and growing margins resulting from cost control efforts. The company is expected to earn $3.24 per share this year, growing to $3.73 and $4.25 in 2014 and 2015, respectively, for year-over-year earnings growth of 15% and 13%. This is very good earnings growth, but although it somewhat justifies the P/E, I think shares have gotten a little bit ahead of themselves at this point.

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