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CBOE: A Robust Stock, Just Not for Dividend Investors

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GuruFocus.com
·5 min read
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There are many ways to look for dividend stocks on the GuruFocus website, including one that's new to me: The Dividend Income Portfolio from the Screeners tab.

After the market closed on July 14, it had just nine stocks that met all the screening criteria, a list that is short because it sets the following criteria for the fundamentals, profitability, growth and dividends:

Options fees provide the lion's share of its earnings. According to the first-quarter earnings release for 2020, $188.5 million of its total revenue of $358.3 million originated with options. U.S. equities was the second-largest contributor at $86.6 million.

Business has been good, with records set during the first quarter of this year when many companies were hurting. That happened because investors turn to options more often when economic conditions are uncertain, and that was certainly the case when the Covid-19 pandemic arrived in the first quarter.

Generally, business has been good for the past 10 years, with CBOE having been profitable in every one of the past 10 fiscal years--that's one of the criteria. The share price reflected that record until the first quarter of this year:

GuruFocus CBOE share price chart
GuruFocus CBOE share price chart

Fundamentals

According to the screener's criteria, a company must show financial strength of at least 6 out of 10, and CBOE meets it:

GuruFocus CBOE Financial Strength
GuruFocus CBOE Financial Strength

It also has to have a profitability rating of at least 7 out of 10:

GuruFocus CBOE profitability
GuruFocus CBOE profitability

The third criterion under the fundamentals is that it have a predictability rank of at least 2.5 out of 5:

GuruFocus CBOE predictability
GuruFocus CBOE predictability

Finally, the fundamental criteria requires a 10-year median return on capital (ROC) of at least 10%. CBOE is well above that, at 79.79%, but within the median is a disconcerting trend. Over the past decade, ROC grew from 69.43% in 2010 to 111.90% in 2014. Since then, however, it has been on the decline, reaching 9.05% in 2019.

Growth

In the growth category, there are two criteria a stock must meet to be in the Dividend Income Portfolio. First, it must have a five-year revenue growth rate averaging at least 5% per year:

GuruFocus CBOE revenue chart
GuruFocus CBOE revenue chart

The second criterion requires that the company be able to turn that increased revenue into increased earnings per share. Specifically, over the past five years, a company should have been able to grow its EPS without NRI (non-recurring items) by an average of at least 5% per year. GuruFocus reports Cboe has increased its earnings per share by an average of 11.5% per year.

Profitability

First, a company must have a 10-year operating margin averaging at least 10% per year. CBOE meets that, but behind the average is a declining rate over the past five years:

GuruFocus CBOE operating and net margins chart
GuruFocus CBOE operating and net margins chart

Second, a company must have been profitable in all 10 of the previous 10 years, and that criterion is found under the heading of Net Margin. CBOE meets that challenge as well, although that's about all we know of that requirement.

Dividends

There are four required dividend hurdles to get into the Dividend Income Portfolio. The first is a yield of at least 1.5%, which is below the roughly 2% average for the S&P 500. At the current share price of $90.54, CBOE squeaks by with a 1.59% dividend yield.

As the below chart shows, the firm also clears the dividend criterion of posting dividend increases for 10 straight years:

GuruFocus CBOE dividends per share chart
GuruFocus CBOE dividends per share chart

To ensure the company isn't dipping too deeply into its earnings to keep raising its dividends, the screen also requires a dividend payout ratio of less than 70%. CBOE is well below that and in conservative territory with a ratio of 36%, leaving ample earnings to be reinvested for future growth and profits.

Finally, a company must have a fice-year yield-on-cost of at least 2.3%. CBOE barely satisfies that criterion with a yield-on-cost of 2.6%.

There is one more matter we should review: a negative stock buyback record. When companies repurchase their own shares, and assuming they buy them at or less than their intrinsic/fair value, the value of the remaining shares should go up. When companies do the opposite and issue more shares than they redeem, the value of each share is diluted. That appears to have been the case in 2017 and 2018 for CBOE:

GuruFocus CBOE shares outstanding chart
GuruFocus CBOE shares outstanding chart

Such dilution is likely to offset any gains from dividends and frustrate investors who want compounding growth.

Conclusion

As we've seen, the criteria for the Dividend Income Portfolio are more rigorous than those for the high-yield dividend screeners. Companies like CBOE that make it through the former screener should be of better quality than those that only qualify for the latter.

Overall, there's much to like about Cboe, but not necessarily as a dividend stock. Its yield and yield-on-cost are too low to attract much attention from income investors, and if the company continues to issue more shares, dividends will be essentially worthless.

The stock appears to be more suited for investors looking for capital gains, assuming they do further analyses to at least understand the declining operating margin and slumping return on equity.

Disclosure: I do not own shares in any companies named in this article.

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This article first appeared on GuruFocus.