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Should you buy ASX Limited?

ASX Limited (ASX: ASX) operates Australia’s fully integrated market for the listing and trading of securities and derivatives. Importantly, the ASX is the sole clearer of all securities and derivatives trading in Australia and has a monopoly position in most markets in which it operates.

Investors have traditionally been attracted to the stock for its high dividend yield, which currently sits at an attractive 4.6%, along with the certainty of the dividend given the company’s near monopolistic position.

The ASX recorded positive revenue growth in all of its seven divisions for the first half of 2014, driven by increasing trading activity in shares and new listings, which resulted in revenue increasing by 8%. However, an increase in operating costs to fund new growth initiatives, such as an over-the-counter (OTC) clearing business, resulted in flat margin growth.

Huge regulatory barriers to entry currently protect the company’s strong monopolistic position within the Australian market and the combination of the clearing and exchange businesses mean that consumers have little choice but to use the ASX. This obviously places in the company in an extremely strong position under the current regulatory environment.

The addition of new products, including tradeable managed funds, future contracts on volatility and sector indexes should help drive revenue growth in the short term. Further, the domestic OTC clearing business is also a growth area with eight major Australian and international banks joining as members and accounting for over 80% of all Australian dollar OTC interest-rate derivatives.

An improvement in Australian and international share markets will be the key driver for earnings growth and future dividend growth. The huge risk to the company would be a change in the Australian regulatory environment that increased the competitive environment, which could negatively impact earnings and the dividend.

Foolish takeaway

At the current price of $36.19, the ASX is fairly valued. Despite the solid dividend yield of 4.6%, I believe future earnings growth will be difficult to achieve. Further, a change in the Australian regulatory environment to allow completion into Australia would have a significant negative impact on the company. Investors would be better to look at other high yielding stocks that also offer the potential for earnings growth, for example Telstra and ANZ.

 

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Motley Fool contributor Bradley Murphy does not own shares in any company mentioned in this article.

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