Securities exchanges are incredible businesses.
Perhaps none more incredible than CME Group (Nasdaq: CME).
CME Group is the world’s leading derivatives marketplace. The company owns four major securities exchanges:
- CME: Chicago Mercantile Exchange
- NYMEX: New York Mercantile Exchange
- CBOT: Chicago Board of Trade
- COMEX: Commodity Exchange.
Together, these four securities exchanges let CME Group churn out massive amounts of free cash flow.
Free cash flow is the amount of money that a business generates after paying all expenses, including reinvesting in growth for the future.
Free cash flow can be used to pay dividends, buy back shares, make acquisitions or improve the corporate balance sheet.
Last year, on $5 billion in revenue, CME Group was able to generate almost $3 billion in free cash flow.
That means CME Group generated a free cash flow margin of almost 60%!
That is just bonkers!
For perspective, a free cash flow margin of 10% to 15% is generally considered very good.
Even the megacap technology companies that dominate the S&P 500 today hit free cash flow margins of only about 20%.
CME Group’s free cash flow margins are so strong because the business requires very few people and very little equipment.
Despite generating $5 billion in revenue last year, CME Group had only 3,460 employees. That means CME Group generates more than $1.4 million per employee.
Not only is the company’s free cash flow margin huge, but the business has rapidly grown the amount of free cash flow it generates over time.
Shareholders have seen free cash flow double every five years.
As you might expect with the free cash flow growth that CME Group has created over the past 20 years, the company’s stock price has flourished.
Over the past 20 years, CME Group’s stock price has outperformed the S&P 500 by more than five times!
This just goes to show that investing in great businesses and holding them for the long term is the way to succeed as an investor.
At CME Group’s stock price as I write, the market is assigning the company an enterprise value of $75 billion.
Against that, the company posted earnings last year of $2.6 billion and free cash flow of almost $3 billion.
That means the company is trading at 28 times earnings and 25 times free cash flow.
On the surface, that doesn’t look cheap.
But this company has been a reliable grower over the past two decades.
Historically, CME Group has traded close to these multiples on average.
Therefore, we likely can’t count on multiple expansion to drive the stock price higher from here, which means that future stock price appreciation will need to come from earnings and free cash flow growth.
But based on the company’s growth history… that doesn’t sound like a bad bet.
One other thing to note…
CME Group pays out almost all of the free cash flow it generates in dividends.
Last year, including three regular dividends and one special dividend, the company paid out $8.50 per share.
On its stock price of $182 as of this writing, that’s a dividend yield of over 4%.
With that yield, an investor doesn’t need a lot of appreciation in the stock over time to generate some excellent returns.
At the company’s current valuation, considering its long-term growth and strong dividend, The Value Meter rates CME Group “Slightly Undervalued.”
— Jody Chudley
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Source: Wealthy Retirement