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When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 14x, you may consider CME Group Inc. (NASDAQ:CME) as a stock to avoid entirely with its 23x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
Recent earnings growth for CME Group has been in line with the market. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. If not, then existing shareholders may be a little nervous about the viability of the share price.
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How Is CME Group's Growth Trending?
The only time you'd be truly comfortable seeing a P/E as steep as CME Group's is when the company's growth is on track to outshine the market decidedly.
Taking a look back first, we see that the company managed to grow earnings per share by a handy 8.0% last year. The latest three year period has also seen a 28% overall rise in EPS, aided somewhat by its short-term performance. Therefore, it's fair to say the earnings growth recently has been respectable for the company.
Turning to the outlook, the next three years should generate growth of 6.0% each year as estimated by the analysts watching the company. With the market predicted to deliver 9.2% growth per year, the company is positioned for a weaker earnings result.
In light of this, it's alarming that CME Group's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
The Key Takeaway
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've established that CME Group currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
And what about other risks? Every company has them, and we've spotted 1 warning sign for CME Group you should know about.