In a previous article, I had looked at using an important financial metric, the return on invested capital (or ROIC), to evaluate the quality of a business. For convenience, I?ve reproduced the formula for the ROIC below:
Generally speaking, a company with a high ROIC has a high-quality business. The reverse is also true ? a low ROIC will correspond to a low-quality business. The simple idea behind the ROIC is that, a business with a higher ROIC requires less capital to generate a profit, and it thus gives investors a…
In a previous article, I had looked at using an important financial metric, the return on invested capital (or ROIC), to evaluate the quality of a business. For convenience, I’ve reproduced the formula for the ROIC below:
Generally speaking, a company with a high ROIC has a high-quality business. The reverse is also true – a low ROIC will correspond to a low-quality business. The simple idea behind the ROIC is that, a business with a higher ROIC requires less capital to generate a profit, and it thus gives investors a higher return per dollar that is invested in the business.
This is important for investors because a stock’s performance is ultimately driven by the long-term performance of its business.
Searching for high ROIC businesses
I thought it may be useful to compare companies in Singapore’s stock market using the ROIC metric; in this way, we may be able to identify companies that potentially have a quality business.
So far, I have placed logistics and postal services provider Singapore Post Limited (SGX: S08) against Singapore Airlines Ltd (SGX: C6L), Singapore Telecommunications Limited (SGX: Z74), Sembcorp Industries Limited (SGX: U96), and Singapore Technologies Engineering Ltd (SGX: S63). Each time, Singapore Post has edged out the competition (see here, here, here, and here).
As I continue looking at the ROICs of various companies in Singapore, the latest challenger I’m interested in is Singapore Exchange Limited (SGX: S68), the sole stock exchange operator in Singapore. The company provides listing, trading, clearing, settlement, depository, and data services. Financial assets that are traded on the company’s platforms include equities, bonds, and derivatives.
With that, let’s look at the ROICs for both SingPost and Singapore Exchange (I’ll be using numbers from both companies’ last completed fiscal years):
After crunching the numbers, Singapore Exchange has come in with a staggering ROIC of 1,889% as you can see in the table above.
Given the nature of its business – an effective monopoly – it’s not difficult to conceive the notion that Singapore Exchange might have a really high quality business. But before anyone gets too excited about that crazy-high ROIC, I think investors might want to adjust the “Tangible capital employed” figure to include the value of software that Singapore Exchange has on its books. The reason for doing so is because software is a critical asset that Singapore Exchange depends on to conduct its business.
After adjusting for software assets with a value of S$140 million, Singapore Exchange’s ROIC comes to 250%, which is still 10 times that of SingPost.
Given the high ROIC sported by Singapore Exchange, it is not hard to see why the company is currently trading at a rich valuation with a price-to-earnings ratio and a price-to-book ratio of 22 and 9.3, respectively.
While all that we’ve seen above can be important and insightful, they should be used only as a starting point for further research and shouldn’t be taken to be the final word on the investment merits of any of the aforementioned companies.
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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 Lawrence Nga doesn’t own shares in any companies mentioned.