If you are considering a new Investment in Kenya, it means you are thinking long term. Investors buy and hold assets for at least one year, in contrast to traders who engage in risky speculation, and could lose money in the process.
You need to pay off most of your debt before investing, and as a rule of thumb, don’t invest with a credit card as it means you are acquiring more debt.
You then need to visit the Nairobi Securities Exchange (NSE) website or download their mobile app to your phone. This will give you a list of all the companies whose stock you can invest in.
The NSE mobile App also lets you compare company stocks side by side, and gives you a history of the companies. It also lets you place stock on a watch list, so you can monitor its performance over time.
Investors need to gather information about the company they want to invest in by studying company reports. Talking with the management of the Company, talking with the staff and distributors of the Company’s products, etc. are alternative ways of sourcing information.
We will discuss some critical factors to consider before investing.
Kenya’s Capital market apex regulator, the Capital Markets Authority (CMA), has licensed 10 stockbrokers.
It is important you pass through only CMA licensed Stockbrokers when investing in Kenya. This is because in the event a Stockbroker becomes insolvent, the CMA will move for liquidation, and you also qualify for compensation from the Investor Compensation Fund. To invest in the Stock market, you must pass through any of the 9 CMA licensed stockbrokers.
Apart from stockbrokers, they are other licensed Capital Market participants such as fund managers, Investment Banks, and forex brokers in Kenya.
Whoever you are dealing with, ensure the person is licensed by CMA.
The NSE is the exchange where all securities are traded. The NSE has different products you can buy to help you create a diverse portfolio. These products are:
- Real Estate Investment Trusts (REITs)
- Financial Derivatives
Other products currently being worked on for offering to the public include
- Global Depository Receipts- so you can buy foreign stock
- Global Depository notes
- Asset-Backed Securities
Risks of Leverage
Leverage is the use of borrowed money from your brokerage to amplify your position. This increases your risk & market exposure.
While leverage can amplify your profits if the market moves in your direction, the trading website Forex Beginner has pointed out that more than 80% of retail investors lose when using leverage. They have warned of the risks of leveraged trading and explained how leverage can amplify losses for investors during a downturn.
Given the risks, investors must stick to investing & not trade on margin as this can result in huge losses.
You need to figure out how much time you have left to achieve your goal. When you are younger, you have more time to learn from mistakes and recoup losses, so you can take higher risks.
However, as you get older you don’t get too many second chances, so high-risk investment should be reduced. To calculate how much you should allocate to high-risk investments like Stocks, you could use the simple formula: 100 minus Age.
If you are 25 years, then it goes like this: 100 – 25 = 75. This means you should allocate 75% of your portfolio to high-risk assets like Stocks, and the remaining 25% to debt instruments like Treasury Bills.
However, if you are 50 years, it also goes like this: 100 – 60 = 40. This means you should allocate only 40% of your portfolio to high-risk assets like Stocks, and 60% to debt instruments like Treasury Bills.
The stock with the cheapest price is not always the best bargain. You need to find out the intrinsic value of the stock. To do this, you should study the company by looking at:
- The Balance Sheet- shows you the net worth of a company at a glance. It helps you to see if the company’s assets are enough to cover its liabilities plus shareholder equity. If the Assets don’t match the liabilities plus shareholder equity, the sheet is not balanced and the Company has a problem.
- The Cash flow statement- tells you how much cash passed through the Company during the reporting period. If the Company makes large profits but the cash that passed through isn’t commensurate to the huge profits, you need to tread carefully as it’s not a good sign. This is because cash is king, and a company with no cash could have problems meeting immediate needs.
- The Income statement- it’s also known as the profit and loss statement. It shows you how profitable a company is. It also gives you a summary of the revenue earned and the expenses incurred during the reporting period. If the expenses incurred exceed the revenue earned, the Company is operating at a loss.
Earnings per Share (EPS)
EPS is a figure that tells you how profitable a company is. EPS compares a company’s net profit, with the number of shares held by its shareholders.
The higher the EPS value, the more profitable the company is perceived to be.
If SACOM (Safaricom) shares cost 34 KSh, and ABSA (ABSA Bank) shares cost 13 KSh, you might conclude that ABSA shares are a bargain since they are cheaper.
However, this may not be true. A stock with a low price may not be undervalued. When the price of a stock is low compared to the profit the company earned, then you can say it is undervalued.
Example 1- calculation of EPS
Assume SACOM shares cost 34KSh, and they earned 37Billion KSh in 2021 with 40B outstanding shares.
Assume ABSA shares cost 13KSh, and they earned 10Billion KSh in 2021 with 5.43B outstanding shares.
The formula is thus: EPS= Earnings / outstanding shares
EPS for SACOM = 37,000,000,000/40,000,000,000 = 0.925
EPS for ABSA = 10,000,000,000/5,430,000,000 = 1.84
ABSA is more profitable not because its share price is low, but because it has a higher EPS than SAFCOM. So if you were considering buying, you may want to buy ABSA.
Price to Earnings ratio (PE ratio)
The PE ratio tells you how investors feel about a share, and how long it will take you to recoup your investments if the earnings of the company remain the same.
PE ratio = Price per share/ Earnings per share
A higher PE ratio means the price of the share doesn’t match the earnings shareholders are paid. It means investors see the potential for growth in the company and are ready to pay more than what the share is worth. If they are wrong and the earnings don’t improve, it could take the investors a long time to recoup their investment.
“Relative price-earnings ratios move up because, people expect either the industry or the Company’s prospects to be better, relative to all other securities than they have been, than their preceding view. And that could turn out to be justified or otherwise” said Warren Buffet, when asked what makes a company’s PE ratio move up, relative to other companies in its industry.
A low PE ratio means the price of the share is commensurate to the earnings paid. It also means the share of the company is not overly priced and overly hyped.
Investing in a company with a low PE ratio means it will take you a shorter time to recoup your investments if the earnings remain the same.
Example 2- calculation of PE ratio
If SACOM shares cost 34KSh and SACOM’s EPS is 0.925 and ABSA shares cost 13KSh with an EPS of 1.84, then:
PE Ratio for SACOM = 34/0.925 = 36.7
PE Ratio for ABSA = 13/1.84 = 7.06
It means that SACOM investors are paying about 36 times more than the real value of SACOM shares. If SACOM earnings don’t grow, it will take the investors 36 years to recoup their investment.
It also means ABSA investors are paying 7 times more than the real value of ABSA shares and if ABSA’s earnings per share remain at 1.84, it will take investors 7 years to recoup their investment.
If you were an investor trying to make a choice, it would be better to buy ABSA shares not because the shares are cheaper but because the PE ratio is lower. You will also earn more per share and recoup your investments in a shorter period.
As an investor, you face market risk, industry risk, and regulatory risk.
To manage these risks, your portfolio should contain assets from different sectors like Tech, Agriculture, Health, etc. so that when one sector slows down, chances are the other one will be doing better. You could also buy into ETFs.
If you don’t diversify, you could be sitting on a time bomb because, if the asset you invested heavily in loses value, you lose everything.
Diversification is a little more than just buying stocks of companies with different names. Stock in your portfolio should have a negative correlation- meaning when one stock rises in price the other one should fall in price.
However, when two stock has a positive correlation, their prices rise and fall together. So a loss of value in one stock could mean a loss of value in the other one too. You could buy stocks of two different companies and still your portfolio won’t be diversified if these stocks have a positive correlation.
When diversifying, make use of a stock correlation to find out the correlation coefficient between two stocks.
For example, if SCOM and ABSA stock have a strong correlation coefficient, this is a positive correlation. It means if SCOM price falls, there is a likelihood that ABSA price will fall too.
In this case, it will be better to buy just one of them to include in your portfolio. If you buy the two, your portfolio is not diversified because if SCOM loses value, ABSA will also lose value.
Stocks are not always what they seem
A smart investor doesn’t buy stocks at face value. An expensive stock of a well-known corporation may not necessarily be the most profitable and a cheap stock may not always be the best buy.
You need to do some more investigation so as to get insight into the intrinsic value of a stock. The PE ratios and EPS give you that insight.
Also, consider how much time you have to achieve your goal, and remember to diversify your investments.