The London Stock Exchange Group PLC’s (LON:LSE) shares are trading close to their all-time high and at a premium to the long-term average price-to-earnings multiple.
So, what’s behind the 33% rise in the value of the business in the year to date – and, frankly, is the current rating sustainable?
To understand the LSE as an investment proposition it is worth getting know what the company is and does.
During that process, it becomes immediately obvious the LSE is more than just a primary and secondary market for shares.
As its full name suggests, it is a group of businesses – spanning information, post-trade services and technology.
The traditional Capital Markets operation made just over £400mln last year, which represents under 20% of LSE’s total income.
Information services
Its biggest operation and the one that slips under the radar for some investors is Information Services, which accounted for 39% of the company’s turnover in 2018.
While Information Services provides real-time data, by far the biggest slug of the £841mln the operation generated comes from FTSE Russell.
People will know it here in the UK as the compiler of the FTSE 100; however, it has an array of indices that are closely followed by tracker and exchange-traded funds around the world.
And the rise of passive investment, which dispenses with the requirement for an expensive and often inconsistent active management firm, has driven some eye-catching growth.
The compound annual rate of expansion of Information Services was 29% for the period 2014-18.
The continued use of passive strategies looks set to underpin that performance going forward as will the unit’s advancement into new international marketplaces.
And, according to the LSE’s June presentation, the income FTSE Russell generates is ‘sticky’. Remember, investors will pay a premium for a high recurring revenue base.
So, we are a little closer to understanding why the LSE’s share price has significantly outperformed its peers and the wider market this year. But we are only part way there.
LSE vs sector and FTSE 100
Another big driver of the current premium rating for the stock is the performance of Post Trade Services, which last year brought in £662mln of income.
Basically, Post Trade Services covers all the boring (mostly electronic) admin that occurs once shares or bonds or whatever financial instruments you care to mention are either bought or sold.
Post Trade Services growth motors
It does this via its majority stake in LCH (formerly known as the London Clearing House).
The latest trading update, covering the first quarter of 2019, revealed Post Trading income had grown 17% year-on-year.
So, the picture we have drawn thus far is of two vibrant, strong operations driving the performance of the LSE, with the stock-in-trade Capital Markets operation marking time and the emerging Technology arm still too small for its impact to register.
But is this enough to support a forward price-to-earnings (P/E) multiple of almost 30 times? That’s racy by any measure, but it is still worth mentioning that’s around two-thirds higher than the P/E rating of the FTSE 100, which is currently around 17.9.
So, what are investors getting by laying out £55 a share?
According to the highly-regarded investment bank JP Morgan Cazenove, London Stock Exchange Group offers the strongest potential earnings growth of any of the European exchanges – placing it ahead of Euronext and Deutsche Borse.
The company’s investor relations page reveals earnings per share are set to grow by 11.5% to 174p this year, rising to 224p in 2020 (an advance of 15% year on year, or a compound annual rate of 13.5%).
And while the P/E may look high, JP Morgan Cazenove said average “take-out multiples” in the sector tend to be around 32-times.
City fan club still intact
That said, the current price of £55.56 is 3.4% above the average price target ascribed to LSE shares by London’s analyst community. That suggests the current price, to use the vernacular, looks a little ‘toppy’.
Yet none of the analysts at the 15 investment ‘houses’ that follow the group appears to be getting vertigo.
We haven’t seen a recommendation downgrade recently; rather the momentum is in the opposite direction, with valuation upgrades from HSBC, JPMC and UBS recently.
And sentiment around the story is positive with two-thirds of LSE’s covering analysts continuing to expect the shares to outperform, while the other five have neutral ratings. In other words, there are no ‘sellers’.
So, it seems the Square Mile very much a fan of the London Stock Exchange – even at these current exalted levels.