In a recent article, I discussed the need to think in terms of decades or even generations when it comes to investing in the stock market. In the article, I mentioned:
“It requires a considerable amount of time for any business to do well. By focusing on the long-term, we are forced to think about the quality and fundamentals of the company we are investing in. If we have an “investing” time frame of just one month, we would only be looking at stock price fluctuations alone, and this will be to the detriment of our portfolio. The daily fluctuation in stock prices will not do any good for our psychological health as well.
However, if our investing time frame is measured in decades or even generations, we will be forced to think about the things that matter: The long-term prospects of a business; the leaders behind a company; and the value of a business. As Foolish investors, we want to invest in companies that have products or services that will not become obsolete in the next few years – ideally, we want companies with businesses that can thrive.”
On that note, I believe local stock market operator, Singapore Exchange Limited (SGX: S68), should earn a permanent spot in your stock portfolio.
I chose Singapore Exchange based on three simple questions, which are inspired by one of the best investors in the world, Warren Buffett. I use these same questions when I look for stocks to add to my portfolio. The questions are:
1) Is the business simple to understand?
2) Does the company have a durable competitive advantage?
3) Will the business still be around for decades to come?
To me, Singapore Exchange has a business that is simple to understand. The firm is the only local stock market operator and regulator in our city-state. It provides listing, trading, clearing, settlement, depository and data services. The exchange is also the world’s most liquid offshore market for Asian derivatives. Furthermore, 36% of the companies listed on the Singapore Exchange are overseas firms. In comparison, the Hong Kong Stock Exchange only has 6% in non-Chinese firms while the United Kingdom’s London Stock Exchange calls just 19% to be non-UK companies.
Due to Singapore Exchange’s size and scale, it would be almost impossible for anyone to try to upend it, in my view. This characteristic gives the company its durable competitive advantage.
Quantitatively, a simple way to find out if a company has a durable competitive advantage is to look at its return on equity (ROE). Generally speaking, a company that has a history of generating good ROE while employing little or no debt has a high chance of possessing a strong competitive advantage. In FY2017 (Singapore Exchange has a 30 June year-end), the firm had an ROE of 33.6% with no debt.
Another way to know if a company has a durable competitive advantage would be to look at its net profit margin. A high net profit margin, usually above 20%, shows that the firm has a sustainable competitive advantage. For FY2017, Singapore Exchange had an enviable net profit margin of 41.9%.
Singapore Exchange is very likely to be around many years from now as it plays a crucial role in Singapore’s status as a financial hub. The company’s strong balance sheet with S$800 million in cash and zero debt (as of 31 March 2018) should enable it to ride through the various economic cycles. Furthermore, the bourse’s three business units of Equities and Fixed Income; Derivatives; and Market Data and Connectivity cover the entire exchange value chain, giving rise to diversified and resilient revenue streams that should be relevant for many decades to come.
The Foolish takeaway
When investing in the stock market, we should look at the long-term, and bother less about short-term pessimism. Hence, by thinking in generational terms, we would be forced to think about the things that matter about a business. In my view, Singapore Exchange should be a keeper in your portfolio. However, before you own a piece of the business, you should ensure that its current valuation makes sense for you.
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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 Limited. Motley Fool Singapore contributor Sudhan P owns shares in Singapore Exchange Limited.