Value Investing and the Nigerian Stock Market

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
Benjamin Graham 

Introduction to Value Investing

Since its founding in the stock market crash of 1929, the teachings of value investing have since spread to different parts of the world. Its founder, Benjamin Graham, proposed the idea of taking a disciplined and less emotional approach towards investing regardless of the incessant vagaries of the wider market.

Fundamentally, Value Investing involves a thorough analysis of all available informational about a company. These include financial statements, non-financial disclosures, and site visits when feasible. Investors are advised to think like business men and to value each company’s stocks with the same degree of seriousness as when buying the entire company.

Valuation is at the heart of a value investing. Intelligent investors seek to answer the question: “What is this business worth?” In financial theory, it is assumed that the value of a business is a sum of discounted cash flows expected over the lifetime of that business. However, since this is impossible to accurately measure in the real world, Ben Graham proposed buying businesses usually for less than they are worth. This helps increase profit as well as make up for false or disregarded information during the analysis. Hence, value investing seeks to place as accurate a value on a business and pay less for such business.

Introduction to the Nigerian Stock Market

The Nigerian Stock Exchange (NSE) was founded in 1960. Since its founding, it has grown to become the third largest stock market in Africa, after the Johannesburg Stock Exchange (JSE) and the Egyptian Exchange (EGX). Added to Nigeria’s status as the continent’s largest economy and most populous nation, the NSE occupies a strategic position in the national financial system as well as presents opportunities for corporations and investors.

The NSE currently lists about 180 companies, with about 60% of the companies actively traded. Products include equities, debt, and ETFs. The NSE has recently seen the surge of government bonds, including the proposed green bond by the Nigerian government.  All market participants are regulated by the Nigerian Securities and Exchanges Commission (SEC).

Value Investing and the Nigerian Stock Market

While value investing has spread beyond the walls of Wall Street, the bulk of its international applications have been limited to major markets in Asia and Europe. So far, almost no investment fund actively applies the principles of value investing, which have been successful in other markets, to the Nigerian market. We believe that the market’s relatively large size (about $120 billion), and the large number of individual and institutional participants, presents an opportunity for disciplined investors to reap huge returns from the misjudgments of other participants.

Companies on the NSE could be divided into two groups based on the intensity with which their stocks are traded and the percentage of ownership by founders. Most of the companies with little trading activity tend to be relatively smaller. These were companies that, until recently, were privately held but went public to slightly increase their capital. Hence, a large percentage of the shares remain in the hands of founders or founding families. These include companies in the agriculture, construction, and pharmaceutical sectors. However, some highly traded companies, like those belonging to the Dangote Group, are still tightly in the hands of the founding families.

On the other hand, companies with high trading activities (like banking and insurance companies) have founders with relatively less share ownership compared to the previous group. A large section of the companies’ stocks are owned by institutional investors like asset management firms, mutual funds, and foreign investment firms. In this group, the original founders and their families rarely own up to 30% of the total company shares.

In light of the aforementioned structure, a value investing strategy on the Nigerian Stock Market would be dependent on each investor’s time horizon, sector expertise and investment strategy (minority purchase vs full buy-out). For companies with huge family ownership, there might greater alignment of interests. Warren Buffett is particularly famous for buying business that are both family owned and family managed. However, the downside to this investment strategy is that minority investors have less liberty at effecting changes since family members tend to have more than 50% of voting power. This effectively rules out the possibility of activist investing.

In converse, the highly traded companies with less family shares presents the classic value investing opportunity since short-term share mispricing is easily corrected. In addition, lax management is easily corrected through activist investing and the threat of a hostile takeover. However, any outright buy-out of such companies would require greater consensus among different players with diverse interest, unlike in family-owned businesses.

Conclusion      

Value Investing could indeed be applied to the Nigerian stock market to reap huge profit. As the continent’s third largest stock exchange and one of the most liquid, huge investment opportunities exist for disciplined investors who adopt a fact-based approach to making investment decisions. There is always the need to understand the national economy as well as factors affecting each industry.  As legendary value investor Seth Klarman once said, “The payoff to value investing rises proportionately with the difficulty of performing it”.

 

 

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