An Investor’s Quick Overview Of The Quality Of Singapore Exchange Limited’s Business

Singapore Exchange Limited (SGX: S68) is the only stock exchange in Singapore. The company has three business lines, namely, Equities & Fixed Income, Derivatives, and Market Data & Connectivity.

As the sole exchange operator in Singapore, Singapore Exchange is no different from a monopoly toll business. As such, investors may intuitively expect the company to possess good economics.

But how do we know that Singapore Exchange indeed possesses a good business? There’s no easy way to answer, but a simple metric can help shed some light on the question: The return on invested capital (ROIC).

A brief introduction to the ROIC

In a previous article of mine, I explained how the ROIC can be used to evaluate the quality of a 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. High-quality businesses tend to have high ROICs while the reverse is true – a low ROIC is often associated with a low-quality business.

You can see how the math works for the ROIC in the formula above.

Singapore Exchange’s ROIC

Here’s a table showing how Singapore Exchange’s ROIC looks like (I used numbers from its fiscal year ended 30 June 2017):

Source: Singapore Exchange earnings announcement

The ROIC calculation for the stock exchange operator throws up something unusual: A negative number. To put this into perspective, we need to understand two things.

Firstly, Singapore Exchange is funding its business using significant amounts of trade and other payables. In this case, the company’s payables of S$891.6 million (as of 30 June 2017) exceeds the total tangible capital requirement of the business.

Secondly, Singapore Exchange runs an asset light business, with significant capital invested into intangibles such as software and goodwill. The two balance sheet items had values of S$159.5 million and S$88.4 million, respectively, as of 30 June 2017. As such, it may be useful to calculate Singapore Exchange’s ROIC with the intangibles included. Such an adjustment will result in an ROIC of 153.9%, which is still a really strong number.

Based on what we have seen above, we can argue that Singapore Exchange indeed has a good business.

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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. The Motley Fool Singapore has a recommendation on Singapore Exchange.