HOW TO CREATE YOUR OWNDIVIDEND PAYING MACHINE

FOR LIFE

Happy Chinese New Year from The Smart Investor!

You know who we are... We are the samepeople who built up The Motley FoolSingapore since its beginnings in 2013.   We thank you, our valued member, for thewonderful years together, and we areinviting you to join us on our new andwonderful journey.

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At The Smart Investor, we believe that if we can find good shares, they could reward youmany times over, regardless of what the market might be doing. We had demonstrated that while at The Motley Fool Singapore. And we will continue to doso at The Smart Investor. Dividend investing is one of the best ways to profit from the Singapore stock market. Thismakes the local stock market one of the best places to build a portfolio of dividend-payingstocks. And that's what our Smart Dividend Portfolio is all about. We want to show you that it is within your reach to find companies that can provide youwith additional income to support your needs, whether it is for retirement, to fund yourchild’s education, or to enjoy the luxuries of life. And this Chinese New Year, as a thank you, we are gifting you with the research that we'vedone on a special dividend paying stock. This stock is going to be added to our SmartDividend Portfolio next month.  Ready? Let's get started...

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YOUR OWN

PERSONAL ATM

A well-constructed income portfolioshould be able to serve your needswhen you need it.  The dividends that come in, as a whole,has to be reliable. And hopefully, thatstream of income will grow with time.  Between stability and risk, the mix ofstocks you choose has to suit your ownneeds. Some of us will seek the reliable flow ofincome, and be less worried aboutgrowth. Other more aggressiveinvestors might be willing to accept alower initial dividend yield in exchangefor higher growth in the future. In short, it really depends on what you,the investor, wants to achieve.  But in whatever mix you end up with,it is always important to have a strongbase of stalwart companies that youcan lean on to generate dividends yearin and year out.

Ideally, this foundation is built oncompanies that are defensiblebusinesses, rich in cash and have thefree cash flow to keep on paying thedividends that you need in your life.  As a continuation to this report, TheSmart Investor has put togetheranother special report, How To Build ASmart Dividend Portfolio in 2020.  In that special report, we will give youa blueprint on how to start building adividend portfolio of your own.  We have a track record of buildingsuccessful portfolios.   After all, David Kuo, co-founder of TheSmart Investor and former CEO of TheMotley Fool Singapore, has earned over$50,000 in under 2 years just from hisPersonal Income Portfolio.  But that was in the past. And it’s time to cast our eyes to thefuture.

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THE SECRET

RECIPE

Cooking up the right portfolio foryourself is like making a tasty dishsuited to your own taste buds.  The first step in cooking is to gatherthe ingredients. In the context of building your ownmoney-making portfolio, that meanshaving the right stocks.  Within a recipe, each ingredient has itsrole to play. In our income-generatingrecipe, the stocks we select need to beof income-generating variety.  And that's exactly the kind of stocksthat we are selecting for our SmartDividend Portfolio. We will be puttingin S$20,000 of our own money intobuying 15 dividend stocks in 6 months.

After gathering the ingredients, what'snext? When it comes to cooking, we need toknow more than just what ingredientsgo into the recipe. We have to carefullyconsider how each ingredient willcontribute to the dish. From there, wewill need to decide how much andwhen to add the ingredients whilecooking.  All of these care and considerationhelps us to pull these separateingredients together to create a lovely,tantalising dish. The Smart Dividend Portfolio will becovering EXACTLY how you can createyour own delicious, money-generatingrecipe.

DIVIDEND

STOCK #1

This free report will provide a glimpseinto one of our 15 chosen dividendstocks.  Without further ado, let’s take a closerlook at it.  This company ticks all the boxes ofreliable income for us.  And the company is …

SINGAPORE EXCHANGE

(SGX: S68)

On stocks, SGX has found its niche asAsia’s largest international REITplatform, attracting listings such asARA US Hospitality Trust (SGX: XZL),Prime US REIT (SGX: OXMU) and EagleHospitality Trust (SGX: LIW) in FY2019.  In October, Lendlease GlobalCommercial REIT (SGX: JYEU) alsodebuted on the local bourse.  Passive investing is catching on too.According to PwC, passive investing inAsia Pacific is expected to reach US$5trillion by 2025.

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SMART DIVIDEND STOCK:SINGAPORE EXCHANGE

(SGX: S68)We think that SGX is worthy for your own watchlist as a stable, recurring dividendpayer for the long haul.    We like it so much, that we plan to buy some SGX stock to add to our portfolionext month. Here is why we like it...

TTM = trailing twelve months; figures in millions except recent price;data as of 3 December 2019

Today, investors can access any stockmarket around the world at the click ofa mouse.  Most Singapore investors willrecognise SGX as the only stockexchange in the Lion City. But thereare other stock exchanges around theworld where you can buy or sell stocks.As such, it is important to know howthe Singapore-based company canremain relevant at the global stage.

WHY WE LIKE

SINGAPORE

EXCHANGE

(SGX)

1. FINDING ITSNICHE IN THE

WORLD

To tap on this trend, SGX has partneredFactset Research Systems (NASDAQ:FDS) to launch thematic indexescovering Asia healthcare, globalcybersecurity, global robotics, Asiatechnology, and global robotics andartificial intelligence (AI). Theseindexes can then be licensed to ETFproviders. Beyond stocks, SGX also excels asAsia’s largest listing for internationalbonds, with over 5,000 listed securitiesby 1,500 issuers from more than 50countries in 20 different currencies.  The company’s bond issuance businessis significantly larger than its equitylisting business. For context, therewere 1,066 bond listings worth S$451.7billion in FY2019 compared to equitylistings which raised S$6.4 billionthrough new and secondary listings.Notable bond listings in FY2019 includethe Temasek Retail Bond and theAstrea private equity bond.  With global interest rates still relativelylow, companies might prefer to issuedebt rather than equity.

Unlike equities, which rely on IPOs tobroaden the market offerings, SGX candesign and add more derivativeproducts for institutional customers inthe future.  For its part, SGX has positioned itselfas a provider of pan-Asian derivativesfor risk management, focusing onequities, currencies and commodities.  The company’s forays into single-country equity indexes, commoditiesand currencies have yielded a numberof highly traded derivatives. 

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Source: SGX annual reports

SGX has three key business segments:market data and connectivity, equitiesand fixed income, and derivatives. The biggest growth driver is itsderivatives business. Between FY2015and FY2019, the bulk of the company’sgrowth came from this segment.

2. GROWTH FROM

DERIVATIVES

In FY2019, six products accounted for87% of the derivative volume traded onits platform, namely SGX FTSE ChinaA50 Futures, Japan Nikkei 225 IndexFutures, Nifty Derivatives, MSCI TaiwanIndex Futures, Iron Ore Derivatives,and foreign exchange (FX) futures. We will be looking to the company tocapitalise on its market position indifferent sectors, including the BalticExchange, to deliver more from thisbusiness segment. Meanwhile, SGX has also signed amemorandum of understanding withthe Industrial and Commercial Bank ofChina (ICBC) and the China CentralDepository and Clearing Co. (CCDC) topromote a suite of ChinaBond-ICBCRMB-based bond indices.

There is an inherent attraction to SGX’sbusiness as a platform. As its businessgrows, the company’s operating cashflow grows, but its capex moderatesover time, leading to higher free cashflow.  In FY2019, SGX was able to turn everydollar of revenue earned into morethan S$0.40 of free cash flow.   The company’s free cash flow acts asfuel for dividends or expansion to newareas.

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3. NEW

GEOGRAPHIES

AND BUSINESSES

Strategically, SGX is positioning itselfas a trusted partner operating a multi-asset exchange.  The company has expanded itspresence to 17 cities worldwide whilepartnering other stock exchanges inChina and India to bring new productsto investors worldwide. Meanwhile, SGX has also invested innew ventures including Trumid, a US-based electronic bond tradingplatform, and BidFX, a specialisedtrading platform for global FX markets 

4. FREE CASH

FLOW MACHINE

Other notable investments includeFreightos, a digital freight platformand CapBridge, a private securitiesexchange built on a public blockchain. Speaking of new technologies, SGX hasalso filed for a patent for automatingthe delivery versus payment processesusing smart contracts which are builton blockchain technology.

This segment, which accounts for 38% of total FY2019 revenue, can be furtherdivided into three sub-segments, namely, issuer services, securities trading andclearing, and post trade services. Singapore investors should be familiar with the securities trading and clearingsegment. For every trade done on the SGX platform, brokers will pay thecompany clearing fees. Revenue depends on the trading volume of stocks, real estate investment trusts(REITs), business trusts, exchange-traded funds (ETFs), daily leveragecertificates, American depository receipts (ADRs), and structured warrants.

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UNDERSTANDING THE BUSINESS

OF SGX

SGX has three key business segments: market data and connectivity, equitiesand fixed income, and derivatives. The split in revenue for FY2019 is shownbelow.

1. FREE CASH FLOW MACHINE

Source: SGX’s FY2019 annual report

As such, if trading volumes go up during volatile times, SGX would earn more. For issuer services, SGX earns a fee on every IPO and secondary offering. Thecompany also earns an annual fee from every entity that is listed on theexchange (read: recurring revenue).

Derivatives is SGX’s largest revenue segment, contributing 51% of total sales.  The majority of the revenue from this segment is tied to the volume ofderivatives traded. Derivative trading in equities and commodities accounted for64% of the segment’s total revenue, with the rest coming from collateralmanagement, license, membership and other. Revenue is dependent on the trading volume of derivatives contracts and theaverage fee of the contracts.

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2. DERIVATIVES

3. MARKET DATA AND CONNECTIVITY

SGX also licenses its market data. The company provides colocation services andconnectivity subscriptions. This segment produces relatively stable and recurring revenue. Connectivitysolutions accounted for 6% of FY2019 while 5% was contributed by market datasolutions.

FINANCIAL TRACK RECORD

When it comes to financials, SGX is a picture of consistency.

Source: S&P Global Market Intelligence

Between FY2009 and FY2019, a period of 10 years, SGX was able to grow itstopline by 4.3% per year and profits by 2.5% per year.  Free cash flow also grew by 4.3% per year with its annual free cash flow margin(free cash flow as a percentage of revenue) over the same period coming in at44.3%. The bourse operator’s ability to generate strong free cash flow has provided thefuel for its growing dividend, which grew from S$0.26 in FY2009 to S$0.30 inFY2019.

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Singapore’s Temasek Holdings owns 23.4% of SGX and is the company’s largestshareholder. CEO Loh Boon Chye has led SGX since July 2015. Notable developments duringhis tenure include the reduction of the lot size from 1,000 shares to 100, theacquisition of the Baltic Exchange, and the broadening of SGX’s derivativesproducts. Senior management remuneration consists of a fixed and variable component.  

OWNERSHIP AND MANAGEMENT TEAM

Beyond free cash flow, SGX’s balance sheet had S$786.5 million in cash andequivalents, as of 30 September 2019, adding a significant buffer to its ability tofund its dividend.

Source: SGX Website

RISKS

Every company comes with risk. Ifyou do not see any risk in a companythat you are studying -- well, lookharder.  The most obvious risk, in our view, isthe decline in trading volume in itssecurities business and the lack ofmajor IPOs. In FY2019, daily averagetraded value (SDAV) fell 17% year onyear.

The fixed portion is tagged to the 50th percentile of Singapore’s banking andfinancial services industry. For the variable portion, up to 50% of the compensation is deferred over a periodof three to four years to keep the management team aligned to the company’slong-term goals.

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Meanwhile, new equity listings raised S$1.7 billion, down from S$6.2 billion inFY2018.  At the same time, SGX was not able to attract local gaming hardware maker Razer(SEHK: 1337) which chose to list in Hong Kong instead.  Another risk is concentration. As we mentioned earlier, most of its derivativestrades come from six products.  To be fair, SGX can still expand its product range in the future. But until then, ifany of its key products fall out of favour with investors, the segment’srevenue could be greatly affected. Elsewhere, SGX has established a S$1.5 billion debt line that it can tap to fundfuture acquisitions. Due to the size of the debt programme, investors should belooking at how the company puts the cash to use.

SGX can serve as the ideal anchor to any dividend investor’s portfolio.  The dividend growth might not excite investors but the fortress-like balance sheetand copious amounts of free cash flow make the company a candidate to buy andhold for the long haul. We hope that you've enjoyed this free report, and wish you all the best in yourinvesting journey. Once again, Happy Chinese New Year!

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GET SMART: YOUR PERSONAL ATM

VALUING SGX

Since 2007, shares of SGX has traded at an average price-to-earnings (PE) ratioof around 23.7 times.

Source: S&P Global Market Intelligence

Today, SGX shares are slightly cheaper at 23 times earnings, suggesting that thecurrent share price is a fair one.  Getting the stock at a PE ratio of around 20 times would be ideal but the stockprice might not always trade at where we want it to be. As such, when we arefaced with a situation like this -- the better move, given what we know, would beto buy a little and add more if the stock trades lower.