Why the ASX Ltd share price is looking up in financial year 2018

The ASX Ltd (ASX:ASX) offers a good mix of defensive cash flows and dividend growth.

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The ASX Ltd (ASX: ASX) share price just hit a 9-year high, but still trades below highs hit before the GFC eviscerated investor confidence and share markets worldwide.

Stock exchanges are hitched to investor confidence and demand for financial assets, as a good part of their fees come from new company listings via initial public offers and other capital markets activity such as share placements.

In good economic times a lot more companies will come to market and generate fees for the exchange, but the opposite is true in tougher times, which partly explains why the local bourse's value is yet to beat pre-GFC boom-time highs.

The other key driver of the ASX's top line is the trading volumes of equities and other exchange traded derivatives such as contracts for difference (cash settled futures) or other synthetic options over multiple security classes. All of their trading volumes are again linked to demand for financial assets and the wider growth of economic activity across the Australian economy.

Is it a buy though?

The ASX is also an attractive investment option as its capital-light nature means it can pay out a high proportion of profits as dividends, as it does not need to reinvest a great deal to generate growth. As much of the growth comes from the external uptick in trading volumes, rather than it having to invest in new assets or staff to grow its business.

The bourse only has a single minor rival in Chi-X and the relatively heavy regulation of capital markets means it is almost impossible to get a license to compete with the ASX as an effective guarantor of trade settlement.

In that sense the ASX has a competitive advantage via its monopoly status similar to other businesses like Transurban Group (ASX: TCL) or Sydney Airport Holdings Ltd (ASX: SYD), but without the substantial downside valuation risks as benchmark debt rates on US 10-year treasuries start to tick higher with cash lending rates.

Another risk or opportunity for the ASX is the fast-changing financial technology (fintech) environment, with the ASX already investing heavily in blockchain research that could potentially see trades cleared and settled instantly.

For example equity bidders could be required to pre-fund orders with cash balances, which would eliminate failed trades and onerous pre-positioning collateral requirements imposed on market makers across the industry.

At $52.70 the ASX trades on around 23x analysts' estimates for $2.34 in earnings per share for financial year 2017 and given the macro outlook of rising benchmark lending rates, I would prefer it as an income pick to the likes of Transurban Group.

Motley Fool contributor Tom Richardson has no position in any stocks mentioned. You can find Tom on Twitter @tommyr345 The Motley Fool Australia owns shares of ASX Limited and Sydney Airport Holdings Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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