Generate Passive Income as This Dividend Payer Eyes a Stock Split

Since 1980, businesses that have announced stock splits have nearly tripled the returns of the S&P 500 Index over the following 12 months. This figure is pretty shocking, as technically nothing changes within a corporation or about its value when it goes through a split.

So what’s going on?

Often, stock splits make high-priced shares more accessible to individual investors — though that impact is diminishing now that brokers widely offer the option of buying fractional shares. Occasionally, the maneuver is used to position a company to join the Dow Jones Industrial Average, which requires a lower share price due to its price-weighted formula.

My highly unscientific theory on why stock splits tend to outperform is that most companies “in need of” a stock split because their prices have soared are proven winners — and winners tend to keep winning. 

This idea brings me to Nasdaq (NDAQ -0.10%) and its nearly 700% share price gain over the past decade. It will undergo a 3-for-1 stock split in late August. It, too, could keep on winning — thanks to its dividend (which at the current share price yields less than 1%), its slim payout ratio of 29%, and its quickly budding software-as-a-service (SaaS) business.

SaaS stability

While cash equity and equity derivatives trading still accounts for the largest single slice of Nasdaq’s sales, its collection of non-trading segments now provides 74% of total revenue. Consisting of Market Technology, Investment Intelligence, and Corporate Platforms segments, the non-trading portion of Nasdaq’s business (collectively called its Solutions segment) is a bit of a hidden gem.

Of the revenue generated across the Solutions segment and the non-trading portion of its Market Services segment, around 70% comes from recurring revenue. This is quietly beneficial for Nasdaq because recurring revenue tends to be incredibly sticky and predictable, coming from customers with subscription contracts.

This stability is critical to Nasdaq as it helps balance out the volume-driven lumpiness around its trading revenue and the broader macroeconomic issues that affect its listings business. Nasdaq’s annual recurring revenue has grown by an average of 11% a year since 2017, bringing consistent growth to formerly volatile revenue figures.

Best yet for investors, management expects SaaS sales to account for 40% to 50% of annual recurring revenue by 2025. These SaaS sales should help improve operating margins over time as Nasdaq develops long-term relationships with customers and brings its portfolio of financial services to bear on a land-and-expand strategy.

Since 2016, when SaaS sales amounted to 21% of annual recurring revenue, their share has risen to 35%. Consider the following chart, highlighting how important these growing SaaS sales are.

NDAQ Profit Margin data by YCharts

While five years is a relatively small sample size over the company’s history, this chart shows the power of Nasdaq’s ongoing transformation. Having widened its profit margin to nearly 20% while seeing its return on equity double to almost 17%, Nasdaq has become a passive income powerhouse for investors.

Passive income potential

An investor who bought Nasdaq 10 years ago when it first started making dividend payments would now be collecting a yield of 10% on their original cost basis, thanks to the company’s track record of payout increases.

Metric Nasdaq
Dividend yield 1.2%
Payout ratio 29%
Earnings yield 3.7%
5-year annualized dividend growth rate 11%
Years of consecutive dividend increases 9

Source: YCharts data 

Since dividend-growing stocks with payout ratios below 50% have historically outperformed the S&P 500 Index, Nasdaq’s blend of steady top-line growth and increasing returns to shareholders should be a winning combination over the long haul.

Despite rough macroeconomic conditions, in Q2, Nasdaq’s net revenue grew by 6% year over year, and its non-GAAP earnings per share rose by 9%. These results highlight the resilience of its recurring revenue and its SaaS focus, which compensated for a drop in trading revenue.

Thanks to this diversification and the steady growth provided by its Solutions segment, Nasdaq should be a stock-splitting winner that keeps on winning, generating increasing levels of dividend income along the way.

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