The financial services industry underwent a massive transformation on July 21, 2010, when the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into federal law by President Obama.
Dodd-Frank was one of the largest regulatory overhauls any U.S. industry has ever seen. It was designed to reduce the concentration of risk in the financial sector. Whether it achieved that goal depends on who you ask.
Today -- almost eight years after it was passed -- Dodd-Frank is about to get a big makeover. This is a profit trigger for the world's largest derivatives exchange and that pays a "secret" 4.5% dividend. Let me explain.
Dodd-Frank Is Set For A Major Overhaul Under The Incoming Treasury Secretary
The U.S. Secretary of the Treasury is one of the most powerful and influential cabinet positions. The Treasury controls federal regulations for business, banking, financial markets, and the IRS while overseeing 100,000 employees.
President-elect Donald Trump's pick, Steven Mnuchin, has major experience in financial services. He joined Goldman Sachs at age 22 and became one of the youngest partners ever. After 17 years he left Goldman and made hundreds of millions managing hedge funds and investing in regional banks.
Mnuchin's top priority when he takes office is to re-configure Dodd-Frank. Specifically, I expect that he will target the Volcker Rule. This Dodd-Frank provision prohibits the big banks, such as JP Morgan, Goldman Sachs and Bank of America, from making speculative bets or trades in derivatives.
Big banks are itching to get back into trading, primarily because it was a big source of income before being banned by Dodd-Frank. These banks are sitting on big cash reserves right now, too. With interest rates so low, consumer loans are barely profitable. They would prefer to use some of that cash to speculate in financial markets and go for a higher return on capital while accepting more risk.
Regardless of whether these trades turn out to be winners or losers, curbing the Volcker rule would unleash tens of billions of dollars into the global derivatives market. And that is a clear profit trigger for the largest derivatives exchanges in the world.
Even if the Volcker rule remains intact, this company is on pace to deliver record revenue in 2017 and pays the industry's best dividend at a 4.5% current yield.
CME Group, Inc. (Nasdaq: CME) is the largest derivatives exchange in the world.
I call it the Amazon of trading. There's no other exchange in the world with a deeper portfolio of derivatives contracts. Their portfolio includes interest rates, West Texas Intermediate crude oil, natural gas, gold, silver, copper, currencies such as the dollar, yen and euro, as well as agriculture markets such as corn, beans, and wheat.
CME Group was the first domestic derivatives exchange to go public in 2003. From there, the company went on a buying binge and consolidated more than 75% of the U.S. derivatives market under its name. In 2007, it purchase the Chicago Board of Trade for $11 billion and the following year it purchased the New York Mercantile Exchange for $9 billion. This string of acquisitions was a major power play by an industry leader, transforming CME Group into the largest derivatives exchange in the world.
The way the CME Group generates revenue is by charging a small fee for every contract that is traded across its exchange. This makes CME Group a clear winner if the Volcker rule is peeled back or adjusted. Curbing the Volcker Rule would unleash tens of billions of dollars into trading derivatives -- and that would give CME Group's trading volumes a serious shot in the arm.
However, even if the Volcker rule remains untouched, I expect CME Group to deliver record revenue in 2017 while paying the industry's best dividend.
CME Group Is On Pace For Record Revenue In 2017
CME Group has been on a roll in 2016. Revenue just hit a new all-time high. Take a look below.
Earnings are on pace to grow 14% this year and are projected to grow another 10% in 2017. And I expect CME Group to use its record revenue to reward shareholders with the industry's best dividend.
One Of The S&P 500's Best And Fastest-Growing Dividends
In a world of low interest rates CME Group is a bright spot. In the last five years its dividend has increased 364%. Those dividend hikes have transformed the CME Group into the best dividend payer in its industry and the S&P 500.
Its regular dividend yield is 2.0%. But in addition to its regular dividend payment, the CME Group implemented a policy in 2012 to reward shareholders with year-end bonuses tied to operating profits and investment gains. That year-end bonus equated to $0.60 per share in 2012, $2.60 in 2013, $2.00 in 2014, and $2.90 in 2015.
When you add in these supplementary dividend payments, CME Group is paying a total yield of 4.5%, more than a 125% premium to the S&P 500's 2.0%.
CME Group's forward P/E of 28 is in line with the industry average of 27. From a historical perspective, CME Group is trading in the middle of its 10-year range, with shares hitting a forward P/E of 37 in 2007 before bottoming out just below 10 during the financial crisis in 2008.
Risks To Consider: CME Group is up more than 20% since November. Although the valuation still looks reasonable, shares are overbought in the short run.
Action To Take: CME Group is the largest derivatives exchange in the world. It also pays the best dividend in the industry that at a 125% premium to the S&P 500. Repealing the Volcker rule would be a profit trigger for the company. Buy shares anywhere below $125. Buy shares before Dec. 23 to receive a year-end bonus dividend of $3.25 per share in mid-January.
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