Guides For Improving Your Capital Market Investment Intelligence
An Article written by Prof. (Ichie) Francis O. Okafor (Ezeugonmuta) as a part of public awareness lecture on Capital Market Investment.
Dated June 27, 2010.
Introduction
One important gift of God to man is the ability to live in the past, to live in the present and to live in the future. Man lives in the past in the sense that his past experiences often guide his present actions. He lives in the present as he selects which action to take and which one to avoid in order to control and manage current events. How does man live in the future-: through efforts, sacrifices and actions taken today in order to impact one’s future one way or the other. God, of course, remains the ultimate decider of man’s future. But He (God) has given man some capacity to think about and to plan for the future.
Planning For The Future:
The future is unknown! Yet it has to be planned for. Planning for the future has both spiritual and economic dimensions. The spiritual dimension obliges us to live in the fear and love of God today so as to qualify to gain eternal life in God here-after. I do not have the necessary training to talk about the spiritual aspect of future living. My talk today is centered on the economic aspect of planning for the future. My intention is to discuss and explain some basic tips and strategies which should guide investment planning and investment management. I hope the discussion will help, at least some of the listeners, to improve their investment intelligence.
Meaning/Type of Investment
People invest in one thing or the other from time to time. But do people get enough information or ask necessary questions before investing? Many people don’t. To begin with, is there agreement on what investment is what it stands for?
In the simplest language, investment means using resources available, at present, to acquire assets which are expected to earn income n future. Therefore every investment involves three things namely: sacrifice (expenditure) of current resources, expectation of future income and some waiting period before the expected income accrues.
There are two forms of investments.
- Real asset investments
- Financial asset investments.
Real Asset Investment:
Investments in tangible assets are described as real asset investment. Real assets produce income directly when put to use. Two groups of real asset investments can be identify namely: single asset investments like buildings, vehicles and investment in groups of real asset which combine to produce a good or service that yields income. Investments in groups of real assets are generally identified as projects. They take various forms like manufacturing outfits, commercial outfits, and service providing outfits.
Real asset investments have two advantages namely:
- The owners are in a position to control or manage them either directly or indirectly.
- Such investments can earn high rates of return if they are successful.
Similarly, they have two major disadvantages
- They often involve cost outlays beyond the reach of the common man.
- The owners suffer a lot of loss if the investment fails.
Financial Asset Investments:
Financial asset investments refer to the purchase of income yielding security issued by companies or by government. Companies can issue and sell two major types of security.
- Equity shares which confer ownership stake in a company
- Bonds which represent creditorship stake in the company
The equity share of a company represents a unit of ownership in the company. It entitles the shareholder to receive a share of the profits made by the company in the form of dividends.
A bond, on the other hand is a unit of debt owed the bond holders by a company. A bond is issued for a specified period of time at the end of which it is repaid (retired) by the issuer. The bond holder has two entitlements namely: full repayment of the bond value at maturity and payment of annual rate of interest each year the bond is held until maturity.
Government can issue bonds if approved by parliament. For example the Federal Government of Nigeria issues the federal government bonds (FGN bonds) on a regular basis. Some state governments have also issued and sold bonds. Governments do not and cannot issue shares! Why? Because no investor should be allowed to buy or to own any unit or any part of government. Government belongs to all citizens – big or small, rich or poor.
The Capital Market
The market for shares and bonds is known as the capital market. It is the market for dealing (buying and selling) in long-term securities issued by companies and by government. The capital market is differentiated from the money market which is the market for short term funds and short term securities.
This discussion concentrates on capital market investments and specifically on investment in equity shares and bonds!
The Capital Market has two parts (partitions) namely the new issue or primary market and the secondary or exchange market.
The primary capital market is the market for selling new shares and/or new bonds issued by companies as well as new government bonds. Only authorized public companies and government can sell new securities in the market. Individual investors can buy from the market. They cannot sell in the market. Investors buy securities issued in the primary market from authorized agents of the issuing company or government.
The secondary or exchange capital market is the market for buying and selling shares and bonds held by investors who had previously bought them from the new issue market. The stock exchange is the centre piece of the secondary capital market. Unlike the new issue capital market which has no specific location; the stock exchange is an organized market with specific locations and regulated operating procedures.
The Nigerian Stock Exchange
The Nigerian Stock Exchange (NSE) started in 1961 as the Lagos Stock Exchange. The exchange was reorganized in 1977 and renamed the Nigerian Stock Exchange. The head office is in Lagos. It has branches in 13 other cities in Nigeria including Kaduna, Porthacourt, Kano, Onitsha, Ibadan, Abuja, Benin, Yola, Ilorin, Uyo, Abeokuta and Bauchi. Another autonomous exchange, the Abuja Securities and Commodity Exchange has been established. However active dealing (trading) on shares and bonds in Nigeria is currently restricted to the NSE in Lagos.
Dealings on the NSE, like in other exchanges are not open to the general investing public. Only accredited dealing members of the exchange, known as stockbrokers and dealers, are allowed to transact business on any of the trading floors of the exchange. Therefore investors, who wish to buy or to sell securities through the exchange, must place their orders through stockbrokers. A stock broker is a stock exchange operator who specializes in buying and selling securities for and on behalf of clients (customers). Stock brokers are paid commissions for their services.
Issues to Consider In Buying
An investor who wants to buy capital market securities should consider a number of issues including:
- Type of security to but (equity shares or bond).
- Which market to buy from (primary market or stock exchange).
- Choice of which company share to buy in preference to others.
- Which bonds to buy (company bonds or government bonds)
- Investment tenure strategy (buying to hold or buying for trading).
Choice of Security to Buy
The basic choice is between buying equity shares and buying bonds. Each option has advantages and disadvantages.
Buying Equity Shares
The advantages of buying shares include:
- Right to receive dividends which could be substantially high and regular if the company is doing well.
- Right to receive bonus shares if and when declared by the company
- Right to receive annual reports of the company.
- Right to be invited to the annual general meeting (AGM) and all extra-ordinary general meetings (EGM’s) of the company.
- Right to vote on any issue placed for voting in the annual general meeting and/or extra-ordinary meeting
- Right to vote for the election of members of the Board of Directors (BOD’s) and members of the Audit Committee of the company.
The above rights and privileges of shareholders seem in theory to be formidable. But are the rights really significant in practice? Much depends on the shareholding stake of a shareholder.
The effectiveness of exercising shareholding rights, particularly the voting rights, depends on the percentage of total shareholding owned or controlled by a shareholder. A majority shareholder can use his voting power to influence company decisions and policies. Small shareholders have very limited influence because they lack block voting power.
The main disadvantage of shareholding is that it exposes the shareholder to the full risk of the business. He gets income only if the company makes profit and declares dividend. If the business fails he could loose a very substantial percentage of his investment shares have no maturity or retirement date. A shareholder cannot compel a company to buy back his shares if he gets tired of them.
Buying Bonds Instead Of Shares
Bonds could appeal to investors who are not disposed to take big risks. Bonds provide some measure of guaranteed annual interest income and total recovery of the amount invested at maturity.
The disadvantage is that the return on a bond is generally low compared to the return on equity shares if the company is doing well.
Which Market To Buy From
Buying from the primary market is only possible when a company makes a public offer. The public offer price is usually a good reflection of the true worth of the share. And it is often a little below the competitive market price of the share at the time of the offer. Moreover commission charged for primary market offers are generally very low. Companies do not make public offers often. Therefore an investor who insists on buying from the primary market may wait for a very long time without achieving his ambition.
The stock exchange provides a regular and steady market for buying or selling the shares of quoted companies. A would-be buyer or seller must, of course, operate through a stockbroker and pay the necessary commission. Timing is critical for success in buying or selling in the stock exchange. The investor must plan to buy when the price is low and sell when it is high.
Most often the ordinary investor may not have the market intelligence to time his transactions properly. He relies on his stockbroker and must therefore engage the service of knowledgeable and honest stockbrokers.
Which Share(s) To Buy
The wise investor is guided by rationality and not by emotion in selecting which company share(s) to buy. Some investors rush to buy every bank share and/or oil industry share on offer. Others target only the shares of big companies. Available evidence however indicates that banks and big companies are not always the top profit performers. The investor should therefore consider the future profit prospects of a company and not its size or industrial grouping.
Which Bond(s) To Buy
If an investor decides to buy a bond instead of shares, then he must first choose whether to buy a government bond or a corporate bond. Government bonds are relatively safer than corporate bonds but they often offer lower rates of return.
Overall Investment Strategy
An investor should develop an overall strategic approach. The approach could be to buy shares of companies with growth prospects. In that case, a buy to hold strategy would be the appropriate approach. If the main consideration is to maximize short term future gains, than a buy to sell strategy is adopted. The approach in this case would be to buy shares whose prices are likely to rise significantly in the near future, sell the shares when their prices rise and rake in the profit.
Issue Of Diversification
In capital market investment, the investor should focus primarily on the prospects of the entire “basket” of securities he holds. The “basket” of securities held by an investor is known as his investment portfolio. The composition (mix) of an investment portfolio is a very important investment decision.
The saying that one should not put all his eggs in one basket applies strongly to investment portfolio management. It implies that portfolio mix should be wide ie it should include different types and not one type of security. The process of including different types of securities in an investment portfolio is known as portfolio diversification. Efforts should be made to form a well diversified investment portfolio. A portfolio is well diversified it is satisfies two conditions:
- It includes: different types of company shares and bonds as well as government securities.
- The performance prospects of the different securities, in the portfolio are not similar such that at each point in time some are doing well even if others are not.
A well diversified portfolio could be formed in the Nigerian Stock Exchange by including shares of companies in different industrial groups (banks conglomerates, food/beverages, paints and chemicals etc). Over 30 industrial groups of companies are quoted on the NSE from which to select. Government and/or corporate bonds could also be included.
A well diversified portfolio protects the investor from the risk of total failure. It also guarantees a stable level of earnings.
Choosing A Stockbroker
As indicated earlier, an investor must engage the services of a stockbroker whenever he wants to buy or to sell securities on the stock exchange. The right choice of a broker is therefore a critical success requirement. The following factors should be considered in making the choice.
- Operating capacity of the broker as reflected by the capitalization and asset base of the brokerage firm.
- Management competence which is reflected by the experience and professionalism of the management staff.
- Integrity of the broker as reflected in the company’s past history of fair dealing and transparency.
- The rate of commission and other fees charge should fall within the industry practice.
Conclusion:
Investment is securities, as in every other form of investment offers income opportunities but carried some risk. The higher the income expectation, the higher the risk exposure. An investor should therefore weigh both the expected income and the projected level of risk before taking his decisions. Traffic wardens have a slogan which says “before crossing a road, look left, look right and look left again before stepping out”. This slogan shouted also guide investors in their capital market transactions.