Why Have Singapore Exchange Limited’s Investors Gained 47% In Value In 5 years?

I think it is fair to say that most investors want to find stocks that can increase in value in the future, either from an appreciation in the share price or through the distribution of dividends.

So, it’s worth keeping in mind the idea that both factors – price appreciation and dividends – are generally derived from the same source, a company’s profit.

This profit is, in turn, driven by a company’s business performance. In general, companies with strong businesses exhibit sustainable growth, high margins, high returns on equity, and low leverage (leverage is a gauge of how much debt a company’s taking on).

In here, I want to take a look at the business performance of Singapore Exchange Limited (SGX: S68) over its last five fiscal years and track the total return of its stock. As a quick background, Singapore Exchange is the sole stock market operator in Singapore.

Here’s a table showing Singapore Exchange’s revenue, net profit, net profit margin, return on equity, and leverage from its fiscal year ended 30 June 2012 (FY2012) to FY2016.

Source: S&P Global Market Intelligence

We can see that Singapore Exchange has exhibited meagre growth in both its revenue and profit from FY2012 to FY2016 – the former has grown by a total of only 26.3% while the latter has climbed by 20%.

But, the company has managed to achieve very high net profit margins and returns on equity. Singapore Exchange’s net profit margin never dipped below 42.7% for the period under study. Meanwhile, the return on equity was consistently above 30%.

The return on equity measures a company’s ability to generate a profit from the shareholder’s capital it is; in general, the higher it is, the better it could be. But, it’s also worth noting that the return on equity can be inflated through the use of higher borrowings. This brings me to Singapore Exchange’s gearing.

The stock market operator has had a gearing of zero for the timeframe under study. In other words, the company has not borrowed any money in the past few years and its return on equity numbers are thus not artificially inflated.

Over the five years ended 16 December 2016, Singapore Exchange has seen its stock price climb by 21%, pretty much in line with the increase in its earnings. But when dividends are factored in, the company’s total return jumps to 47%.

Singapore Exchange’s experience highlights two important ideas in investing: (1) A stock’s price performance is often driven by its business performance over the long-term; (2) Dividends can be an important component of a stock’s return.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore has recommended shares of Singapore Exchange. Motley Fool Singapore contributor Lawrence Nga doesn’t own shares in any companies mentioned.