The subject of equity (or equities), on the face of it, may not sound new to many. However, I would be correct in stating that understanding what equities are, is worth exploring for the benefit of all. Again, perhaps your mind is calling for clarity on this: “Are there different types of equities?” Or, “what are the returns as well as the associated risks”. For others, the questions may include: “Who invests in equities?”, “Where can I buy (or sell) equities?” and “How do I know what is right for me” among others. Fret not. Let’s learn from Emefa’s experience.
Emefa owned shares in a company, ‘ChildrenRus’, that manufactured children’s ware — clothing, toys and childcare products. It was initially founded in 2004 as a private company but after ten years, it became a public company and listed on the stock exchange. That was when Emefa became a shareholder. She became a part-owner of the company by virtue of her purchase of a share of the company.
Over the years, the then private company’s fortunes had flourished steadily and management had seen potential for growth in the export market. Sales to distributors who exported to neighboring countries were increasing and the company’s profits had soared. It was on the back of this that a decision had been taken by management to expand operations into markets beyond the borders of the country, among others. This had required capital and management had proposed going public (with a listing on the stock exchange) to raise the funds. It was at this point that Emefa had bought shares and become a shareholder of ‘ChildrenRus Company Limited’.
A share of a company (or financial asset) is a single unit of ownership of the company (or financial asset). When a company is formed, it has authorized shares. These are the maximum stated number of shares it is allowed by law to sell to prospective shareholders, usually members of the public or institutions. The total number of shares already sold is referred to as the number of issued shares and those to whom these are sold are the shareholders of the company. Shareholders are the owners of the company. They decide on all major decisions for the company and vote on these at a general meeting of shareholders, usually called AGM (Annual General Meeting) simply because they are held annually. If, during the year, a major decision has to be taken by shareholders, an extraordinary general meeting’ can be called for voting on the issue to take place. Shareholders are also entitled to participation in the company’s profits and they receive dividends when declared.
Shares are termed equity securities and exists as different types or classes. A company can theoretically have as many types of shares as shareholders deem fit, so long as they don’t conflict with legislation governing the issue of shares by companies. In Ghana, the common types of shares or equity securities issued are ordinary shares, preference shares and exchange traded funds (ETFs). Ordinary shares are, again, the most common. They entitle holders to voting rights and dividends. Preference shares, however, usually do not give voting rights to holders but they confer payment of dividends before ordinary shareholders can receive their dividends. Preference shares are, therefore, thought to be safer to hold (in terms of income payments) than ordinary shares.
ETFs are a bit different. They are securities traded on exchanges, just like shares. However, they track the combined value of a portfolio or basket of underlying assets such as shares, commodities and bonds. ETFs give owners a share of capital gains (profits) on these underlying assets without direct ownership of the assets. NewGold ETF, issued by Absa Capital, tracks gold prices and is listed on the Ghana Stock Exchange.
When Emefa first bought shares in ChildrenRus, she was informed that shares are usually risky and should be viewed as long-term investments. Well, then 25 years of age, she could stomach the risk a lot more than currently, fifteen years later. The riskiness of shares is for a number of reasons:
- there is really no guarantee that the company will do well financially, and by extension, that its share price will increase
- a story in the news media about ChildrenRus, its sector or the country/region the company operates in could cause investors to abandon the stock (sell them off) and drive its price down. Primarily, the market operates on the basis of demand and supply.
- if the company goes bankrupt or it fails, shareholders would receive payment only when all debtholders/creditors have been paid fully; there may be nothing left to pay shareholders
- the ability of a shareholder to sell his/her shares at a certain price depends on the availability of a willing buyer at that price; a shareholder could be stuck with shares if a buyer cannot be found
Nevertheless, Emefa had believed the company had a good model and would do very well. Fifteen years later, she could look back and say the ‘gamble’ had paid back handsomely. It wasn’t really a gamble per se, because she had spoken to her investment advisers and she had known, from her own investigations, that there was a good chance that the company’s fortunes would flourish.
Where the risk is high, the return/profit is usually also high. This is generally true for investment securities. Most share prices rise and fall because of company performance or market sentiments. Even more, the rise and fall variations often show a trend of increasing share prices.
For these reasons, equities are usually best suited for long-term investments and investment advisers generally recommend that young people invest in them. At a younger age, investments in shares can be given time to traverse all the up-and-down share price movements as it increases. Over a period of ten years, a lot of carefully selected stocks could return handsomely for investors who have the heart and the time.
Stocks that are listed can be purchased from licensed brokerage firms. It is always a good thing to ask about the stock before buying and the advice the investment adviser would give serves as a great guide. The decision lies with the investor and every investor needs guidance. Shares that are on the market are open to any member of the public to buy where they are available. The openness to the general public lends liquidity- there is a whole lot of people who could participate in the trade of listed shares.
A few other shares are tradeable among the general public but are not listed, and therefore, do not trade on the stock exchange. These shares trade in what is termed as the ‘over-the-counter’ (OTC). Since it is not open to the general public, news of the availability of shares to purchase are kept among a few interested parties. Opportunities for everyone to own a piece of the company are hampered because trading involves a limited number of investors.
Once fortnightly, Emefa evaluates her position (number of shares she owns). Her objective for investing in the shares is to grow and expand over the years. During those years, she has seen the shares grow from GHS 0.20 per share to GHS 15.72 per share. Most importantly she remembers there had been a period the price went down from GHS 5.25 to GHS 1.89 and she almost sold all her shares. However, after reading reports that the company had turned the corner in performance, she held on and bought a few more shares. Emefa is glad today, that she had.
Shares are invested in for a number of reasons — for capital growth, for income, and for undervalued shares. Where the objective is solely for growth, investors look out for growth potential. If a company is venturing into a new market which looks promising or is launching a revolutionary product, there is a good chance that the company’s share prices will rise up and be sustained for some time. An investor interested chiefly in growth would find the company’s stock attractive and worth buying. The investor would look out for how strong the company’s management team is, the number of years of relevant experience the team has and their track record. Additionally, the investor would want to consider the company’s sales performance history. A strong record could have a sales growth of more than 10% for the last 5 years, for instance. Also, if the company is in a strong growth market and the company is a leader with the ability to sustain its competitive advantage, that would make its stock a good target for growth investors.
Income stocks typically pay consistently high dividends to their investors. Many companies that have built fortunes earlier and are stable, have high dividends paid out regularly paid out to investors. Investors are therefore rewarded by receiving dividends regularly.
Some stocks, compared to their peers in the same sector, have metrics like low (Price-to-Earning) P/E or Price/Book Value, compared to peer company stocks. A stock’s value (price on the market) can be compared to the average P/E ratio in its sector or the market. An undervalued stock would have its P/E ratio smaller than the average P/E ratio for the sector or market and this would yield a ‘buy’ recommendation for value investors. If its P/E ratio is higher than the average in the sector or market, the stock is said to be overvalued. This would elicit a ‘sell’ recommendation to value investors.
I hope you remember Emefa bought shares in ‘ChildrenRus’ as a growth stock. For the first ten years of the company’s existence, it did not declare dividends. It ploughed back profits it began to make after three years into the company to sustain its operations and reduce borrowing. An expectation to receive income through dividends would have been disappointed, until much later. The company’s P/E and Price-to-Book value ratios had been comparable to its sector’s P/E and Price-to-Book Value ratios so that indicated the stock’s non-suitability as a value stock.
The best thing to do is to speak with an investment adviser. Their research and analysis would guide you to select the stock that is right for our purpose and is suitable for the investment objectives we have selected. The risks associated mean it pays to get advice to help us get it right first time. It will be a great pleasure for me or any member of the OctaneDC team to help you on your investment journey. Please get in touch and let’s have a conversation.
About the Writer
Kwadwo is a Senior Investment Analyst at OctaneDC Limited and heads OctaneDC Research. Prior to joining OctaneDC team, Kwadwo was a Fund Manager at Dalex Capital and has over a decade experience in fund management and administration, portfolio management, management consulting, operations management and process improvement. You may contact him at [email protected] or +233244563530