In a declining market, the highest quality companies often still achieve high multiples due to their competitive position in their respective markets. If a company has a competitive advantage, e.g. e.g. being the first to enter a market with high barriers to entry, it often retains a premium multiplier.
Here are two such companies that are either part of a duopoly or have monopolies on certain important products. These companies can sometimes go cheaper, but rarely go “cheap”. Let’s find out a little more about these two hot stocks that live up to their high valuations.
1. American tower
American tower (GOVERNMENT OFFICE -0.84%) is a mobile real estate investment fund (REIT) operating in a duopoly Crown Castle International. Cell tower REITs have an incredibly stable business model and are benefiting from a long-term trend towards increasing mobile data usage. The company builds cell towers and then leases capacity to cell phone providers, television and radio stations, and government tenants.
American Tower’s business is characterized by significant barriers to entry. While there are other smaller competitors, the two heavyweights dominate the industry and own the best tower locations. With over 200,000 towers worldwide, American Tower is truly a global player.
Global data usage has increased as cell phones become more data-driven. According to a study, by the end of 2021, the typical user was consuming 15 gigabytes of data per month. By the end of 2027, this is expected to increase to 52 gigabytes per month, at a cumulative average growth rate of 24%.
American Tower forecasts adjusted funds from operations (AFFO) of around $9.72 per share for 2022. REITs generally use funds from operations to describe earnings because depreciation and amortization are such large factors in earnings per share. Depreciation and amortization are non-cash costs, meaning this is more of an accounting issue than a cash flow issue. At current levels, the stock trades at 26 times the 2022 affine AFFO per share, which is expensive for a REIT but worth it for a market leader. Another thing worth noting: American Tower has increased its dividend every quarter since 2012.
2. CME Group
CME group (CME 0.06%) is one of the largest futures exchanges in the world. Your portfolio includes the Chicago Mercantile Exchangethe Chicago Chamber of Commercethe New York Trade Exchange, and several other platforms. CME Group is best known for its dominance in interest rate derivatives. Businesses generally use interest rate derivatives to hedge cash flow streams and capture borrowing costs or borrowing yields. Businesses often trade in the foreign exchange market and use derivatives to hedge expenses and income in other countries.
CME Group struggled during the COVID-19 pandemic as the Federal Reserve cut interest rates to the bottom to stimulate the economy. Since interest rates generally cannot go below zero, commercial traders will not bother to hedge against this risk. This led to a drop in trading volume in its flagship interest rate products. However, the Fed is now aggressively raising rates to fight inflation, which will lead to more trading volume. In the first quarter of 2022, the average daily volume in interest rate products increased by 21% year-on-year.
CME Group is trading at 26.6 times expected 2022 earnings per share. This might seem like an expensive multiple given that multiples have shrunk since the beginning of the year, 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.
Brent Nyitray, CFA, has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends American Tower and Crown Castle International. The Motley Fool recommends CME Group. The Motley Fool has a disclosure policy.