The Motley Fool

Should You Own Singapore Exchange Limited for the Long Term?

Singapore Exchange Limited (SGX: S68), or SGX for short, is the only stock exchange in Singapore. In the last five years, SGX’s share price fluctuated between S$7.00 to S$ 8.50. At S$ 8.49 today (as of writing), its share price has not changed much over the period.

This caught my attention and got me interested in finding out more about the company. In particular, I want to understand: Does it have a high-quality business?

This question is important. If SGX has a high-quality business, this could be an investment opportunity. Unfortunately, there’s no easy answer to the question. But, a simple metric can help shed some light on the question – the return on invested capital (ROIC).

A brief introduction of ROIC

In a previous article, I had explained how to use ROIC to evaluate the quality of a business. For convenience, the maths needed to calculate the ROIC is given below:

Generally speaking, a high ROIC will mean a high-quality business while a low ROIC will point to a business of low quality. This is important for investors as a stock’s performance is often tied to the performance of its underlying business over the long term.

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.

Here’s a table showing how Singapore Exchange’s ROIC looks like (I had used numbers from its fiscal year ended 30 June 2019):

 

Source: Singapore Exchange FY2019 Financial Results

In its fiscal year ended 30 June 2019 (FY2019), Singapore Exchange generated an ROIC of 766%. This means that for every S$1 of capital invested in the business, Singapore Exchange earned S$7.66 in profit.

The company’s ROIC of 766% is at the top quartile, based on the ROICs of many other companies I have studied in the past. On the surface, this suggests that Singapore Exchange has a high-quality business.

SGX’s business model

Nevertheless, there are two points worth mentioning. First of all, Singapore Exchange is funding the business using a significant amount of trade and other payables. In this case, trade payables of around $912 million has covered the bulk of the company’s working capital and tangible assets invested.

Secondly, Singapore Exchange is an asset-light business, with significant capital invested in intangibles like software and goodwill. As such, it might be useful that investors carry out a separate ROIC calculation that includes these assets. Adjusted for intangible assets, the ROIC would have been about 120%.

Foolish takeaway

In sum, both of its high ROICs (including the adjusted-ROIC of 120%) suggest that Singapore Exchange has a high-quality 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 recommended the stock of Singapore Exchange Limited.