Is Singapore Exchange Limited Good Enough to Buy Now?

At the Fool, we believe that in order to find good shares to invest in, one has to start with figuring out how strong a business is.

And to do so, we can turn to the Rule Maker framework outlined by Motley Fool Chief Executive Officer Tom Gardner in his book Rule Breakers, Rule Makers.

The Rule-Maker Framework

Here’s how the framework looks like:

  1. Is the company selling low priced, everyday items?
  2. How does the business’s gross margins look like?
  3. What about its net margins?
  4. Is the company’s sales growing?
  5. What about its cash to debt ratio?
  6. Is its Foolish Flow Ratio (a gauge of how fast the business can bring in cash) strong?
  7. Lastly, what’s your level of familiarity and interest with the business?

Figuring out SGX

With that, let’s run Singapore Exchange Limited (SGX: S68) through the framework today. As a stock market operator, Singapore Exchange – or better known as SGX –  gets its revenue through a number of different business segments: Securities, Derivatives, Market Data and Connectivity, Depository Services, Issuer Services, and Others.

You can read more about the company in here and here. We will use SGX’s figures for its financial year ended 31 June 2014 (FY2014) in this exercise.

Here’s how SGX has fared against the Rule Maker framework (numbered in the same order as the seven criteria above):

  1. The stock exchange that SGX runs is akin to a marketplace in which investors can buy and sell shares of different companies. SGX levies fees from the listing of securities, as well as for the clearing of securities trades and derivative contracts. It also earns its keep by providing market data feeds for risk management and back office applications. Although SGX’s revenue will rely in part on the level of activity in the stock market, the company’s source of revenue can be considered “everyday” in nature.
  2. As a stock market operator, we can use the firm’s operating margin instead of gross margin. In FY2014, the operating margin for SGX clocked in at a healthy 54.1%.
  3. Moving on to the net margin figure, SGX also kicked in a marvelous 46.7% for the same period.
  4. SGX’s top-line has grown by 3% annually over its past five financial years. It should be noted though that SGX’s revenue had declined by 4% in FY2014.
  5. As of 31 June 2014, SGX had $756.9 million in cash and equivalents, and no debt. This gives a cash to debt ratio which is well above Tom’s desired figure of at least 1.5.
  6. As of 31 June 2014, SGX had $756.9 million in cash, $1.4 billion in current assets, and $699 million in current liabilities. This gives a Foolish Flow ratio of 0.90, meeting Tom’s requirement. In general, a ratio of less than 1 is considered good.
  7. It is hard to judge the level of interest in the company for each individual, but it is possible that the services that SGX provides are easy enough to follow for most investors.

Foolish takeaway

Putting a company through the Rule Maker framework can help you size up the type of opportunity at hand.

With SGX, we might see a company with a monopolistic position that’s able to bring in great profit margins that reflect that dominance. That said, revenue growth has been slow.

As the only stock market operator in town, SGX’s fee-based model also provides stable cash flow. The company has excelled at hanging on to the cash which flows through, and this is seen in both its healthy Foolish Flow ratio and strong balance sheet with no debt.

On the flipside, SGX does compete with regional stock exchanges for new company listings. To grow, the company has to expand into new areas like commodities trading as well as ensure that it remains a relevant platform for various trading services in the future.

As a final note, it is important to understand that no one company is perfect.

With the characteristics defined above, the onus remains with the Foolish investor to decide if SGX’s current share price provides an appropriate margin of safety and whether it fits into his or her portfolio.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.