

After not making any new capital purchases in any of my portfolios, other than my 401k, since July 2015 I was finally able to make a purchase and get back to building up our dividend stream.



The pause wasn't for lack of trying or opportunities, rather it was due to the fact that since 2014 our lives have been one huge whirlwind. Think a snow globe once you shake it up.



This purchase wasn't made with fresh capital that was added to the account, but was from dividends stacked up over the year and some options trading profits. Nevertheless, it feels good to finally make a new purchase for my portfolio.





On February 6th (has it really been that long ago already???) I purchased 21 shares of CBOE Global Markets, Inc. (CBOE) for $115.08 per share. The total cost basis including commissions came to $2,421.63 or $115.32 per share.



CBOE is a Dividend Challenger with 8 consecutive years of dividend increases. CBOE's most recent quarterly dividend payment was $0.27 per share. That puts the YOC for my position at 0.94% and I can expect to receive $22.68 in dividends over the next year barring any reinvestment or dividend increases.





Due to this purchase my FI Portfolio's forward 12-month dividends are $6,023.83.



How Does CBOE Make Money?



What attracted me to CBOE is that they are a quasi-toll bridge company which is one of my favorite moats that a business can have.



CBOE is an option exchange company that operates in 5 segments: (1) Options (2) U.S. Equities (3) Futures (4) European Equities and (5) Global FX. CBOE also has proprietary products most notably the VIX or volatility index. Some of the exchanges under CBOE's control are the large U.S. option exchange, the largest stock exchange by value traded in Europe as well as the second largest stock exchange operator by volume in the U.S.



CBOE makes money primarily through regulatory fees, transaction fees, market data fees and connectivity fees as well as the licensing of their proprietary products. The bulk of their revenues come from transaction fees or in other words their like the Visa (V) of the investment world by charging a small fee for every transaction they facilitate.



Financials



CBOE has consistently grown revenue, operating income, net income and free cash flow since 2008. The wonderful thing about the business model is that as transactions increase their business increases along with it. The large jump in 2017 was due to the merger with Bats, another exchange.









One of the reasons that I'm attracted to the toll road style moat is that these businesses typically have a high barrier to entry and with that comes a high profit margin.









Dividends



The dividend is obviously another factor that I like to examine before purchasing shares of any company. As I mentioned earlier, CBOE has increased dividends for 8 consecutive years.







So far management has shown a commitment to increasing the payout to shareholders each year and should announce another raise in late July.



The 1-, 3- and 5- year rolling dividend growth rates can be found in the chart below. CBOE has grown dividends quickly, although the 2 most recent increases both came in at less than 10% per year which is a bit lower than I'd like to see for a company with a sub-1% starting yield.







With dividend growth outpacing earnings and free cash flow growth it should be pretty obvious that the payout ratio was due to expand. However, the payout ratio is still at very manageable levels hovering around 30% on both a net income and free cash flow basis.



One of the downsides to the merger was that it required around a 30% increase in the shares outstanding to facilitate the deal. However, I also take that as a positive sign since the payout ratio, despite paying dividends on 30% more shares, didn't jump and actually declined from 2016 to 2017.



Prior to the merger related share increase, CBOE's share count had generally been declining more often than not. In 2008 the share count was 93 M and by the end of 2016 the share count had fallen to 81 M or a 12.9% decline.



Valuation





The valuation could have been better for me to initiate the position; however, I'm comfortable paying up slightly for a company that I think still has a long growth runway.



Based on 2017's announced earnings of $3.71 per share my purchase price sports a 31.1x P/E ratio. Using 2018 and 2019's estimates of $4.52 and $4.99, the forward valuation is 25.5x and 23.1x, respectively. Like I said not ideal, but for a company with a fairly strong moat and still room to run for growth I'm comfortable with the valuation.



Further helping out my cause is the analyst estimates for growth of 17.9% per year for the next 5 years. I try not to place too much faith in analyst forecasts, especially 5 years out, but it's a good sign that there's growth ahead for CBOE. Even if it's just half their forecast I think this investment will do just fine.



The following chart shows the future expected share price for CBOE using earnings estimates of $4.52 for 2018, $4.99 for 2019, 12% per year growth for the next 3 years and 7% annual growth for the following 5 years. I've used P/E ratios of 15x, 20x and 25x.







Another very rough valuation technique is to use the Dividend Discount Model. Instead of solving for the price with an assumed growth rate, for a quick and dirty valuation I like to solve it backwards by figuring out what kind of growth rate is required to justify my cost basis at the time of purchase.



Using $1.08 as the starting dividend, my cost basis of $115.32 and a 10% required annual return, CBOE needs to average at least 8.98% annual dividend growth in order to support my purchase. I feel that's a very reasonable level that CBOE should be able to hit and it likely represents the floor, or fairly close to it, for what CBOE can deliver in annual dividend growth.



Conclusion



This probably wasn't the ideal purchase/valuation point to add shares of CBOE to my portfolio; however, after over a 2.5 year hiatus between purchases I'm not surprised that I jumped the gun a bit.



Despite paying up some to start my position in CBOE I still think this investment will turn out fine over the long term. CBOE has one of my favorite moat styles, a history of solid growth and require <10% of their revenue to be devoted to capital expenditures in order to grow while generating free cash flow at a 30% clip.



What do you think of my purchase of CBOE Global Markets? Have you looked at CBOE or any of the other exchanges before as a potential investment?



