Published in The Financial Express on 30.11.2014. Link: http://www.thefinancialexpress-bd.com/2014/11/30/68611
Investing in the share market was never the first choice for Bangladeshi savers to earn some return. People who earn in excess of their regular expenditures usually end up saving their money in commercial banks as savings account or fixed deposits. This allows commercial banks to provide more loans to businesses and other enterprises and thus debt financing has become the most popular form of financing any project, asset or business in this country. Even big public limited companies who issue shares in the share market do not usually intend to gain much capital through the sale of shares. Rather they heavily depend on taking loans from banks and paying periodic installments which comprises of the principal and interest amount. The increased dependency on loans can increase the chances of bankruptcy and in an extreme case debt crisis. But even then this form of financing is considered less risky than equity financing through issuing and selling shares. This happened due to the high risk associated with the share market of this country. There is no guarantee that investors will be purchasing newly issued shares and so in cases of emergency capital requirement by public limited companies, bank loans are easier and safer. The news concerning the share market that the general public got in the last few years were rarely good news. They always saw that people made huge losses due to the downturn of the market and thus they made processions and protested violently. This discourages any new potential investor to even consider putting their hard earned money in the capital market. The older and more religious generation has gone as far as considering share investment equivalent to gambling and thus refrains from such “haram” activities. But can you imagine how much benefited the capital market and the economy of the country would have been, had these people put in their pension funds in the share market? But who is to blame them seeing the state of the market.
My opinion is that the major reason behind the riskiness of the share market is because the fundamental idea of a share has been lost amidst all the impulsive gambling attitude of traders. Nick Leeson, the infamous rogue trader of Barings Bank in England, had said in his book that the market is one giant casino and that is exactly how the investors are viewing it in Bangladesh now. Shares are portions of the ownership of a company. Shareholders forget the fact that they own a portion of a big company and the companies themselves forget the fact that these investors are actually their owners. Both of the parties, managers of the firm and shareholders, should be responsible for each other. So any profit or loss of the company should be reflected in the profit or loss of the investor and vice versa. That does not mean that each of the shareholders should get involved in the operation of the companies. But the financial intermediaries like brokers and investment banks should facilitate each of the parties to act for the benefit of the other. However, such is not the case in reality. I have heard from people who work in investment banks that there have been situations where the stock price of a particular company has risen, though the company stopped production.
The share prices that we see in the market and in the business section of the daily newspapers are determined like the price of any other commodity in a free-market economy. That is through the demand of buyers and the supply of sellers. The most basic theory of economics suggest that when the quantity of a commodity the buyers demand, at a certain price, matches with the quantity the seller wishes to supply at that same price, then that price is determined to be the market price. So if majority of the buyers of Stock A demand its price to be Tk.100 then the seller will have no other option but to supply the stock at Tk.100. And so Stock A’s market price becomes Tk.100. This demand for a particular stock at a particular price is determined by the buyer’s perception regarding the future return and risk associated with that stock. Normally in Bangladesh the perception of buyers is built on past or historical return and risk of that stock. Since the buyers wish to make profit only by selling the stock at a higher price, thus they look at the past market data to try and find a trend of price increase. This is called the trend or technical analysis of stock price.
Now, had the risk and return perception been determined based on the current profitability of the company then the buyers would have demanded a price that was directly or indirectly related to the successful operation of the company. Instead of trying to profit out of a price increase the investors can try to gain from the company’s operational profits paid in the form of dividends. Let the trend analysis be done on the company’s past dividends rather than the past stock price. There is another theory of economics that finance has adopted. It suggests that any asset’s true intrinsic value is based on its ability to generate cash now and in the future. If such is the case then the true value of a share should be its ability to generate dividends now and in the future. And investors should demand price based on the intrinsic or true value of the share. If the price of the share does not reflect the intrinsic value then on what basis are the investors gambling their money? How can making money on nothing but the demand for a piece of paper be productive for the economy?
Dividends will be paid by the company only when they make profit. So if the prices of shares are determined through the dividends then the investors will be closely monitoring the operation of the company. This will keep the managers of the companies concerned as then the way they run the company will be affecting the direction of the stock price movement. This is where the brokers and investment banks can play a big role. Since they are the mediator in between issuer of the share and the investor, they can calculate the intrinsic value of the shares that they trade with the help of the company’s profitability data and educate the investors about them. In this way the investors will be constantly aware of how their money is being used. The tendency of holding shares for a short period of time to realize only capital gain will also diminish and investors will be thinking long term with their share.
There still lies a problem, that the decision to pay dividends is entirely on the company’s management and thus some public limited companies in our country do not pay any dividend even when they are making profits. This discourages investors to look for dividend gains and focus more on capital gains by selling shares at a higher price. Thus the gap between the industrial market and the capital market widens. Government can intervene here by encouraging firms to pay regular dividends and bridge the gap. This way, external factors like political turmoil, tax, and economic environment will not have any direct impact on the demand of stock prices rather they will impact only on the operation of the company and its profit. The intrinsic value calculation of the share will automatically incorporate such external factors. When the intrinsic value of a stock equals its demanded market price then it is said to be at equilibrium. Continuous equilibrium for majority of the shares makes a market efficient and this will boost up the confidence of savers on share investment.
Things are not as ominous as this article may suggest. Investors today are much more educated about the capital market than their predecessors were a decade ago. People understand the importance of the relation between true intrinsic value of the stock and the operational success of the company. Measures like the Price-Earnings ratio, which finds the relation between the earning ability of the company and the price of its shares, have become an important indicator of stock return to investors. However there still exist some big syndicates who try to manipulate the stock prices through their sheer financial power and gambling attitude and a few ignorant investors who fall in their traps. A little bit of controlling mechanism from the governing bodies and more educated investors, guided by professional brokers and investment banks can make stock investments very lucrative and a major contributor to our economy.
Investing in the share market was never the first choice for Bangladeshi savers to earn some return. People who earn in excess of their regular expenditures usually end up saving their money in commercial banks as savings account or fixed deposits. This allows commercial banks to provide more loans to businesses and other enterprises and thus debt financing has become the most popular form of financing any project, asset or business in this country. Even big public limited companies who issue shares in the share market do not usually intend to gain much capital through the sale of shares. Rather they heavily depend on taking loans from banks and paying periodic installments which comprises of the principal and interest amount. The increased dependency on loans can increase the chances of bankruptcy and in an extreme case debt crisis. But even then this form of financing is considered less risky than equity financing through issuing and selling shares. This happened due to the high risk associated with the share market of this country. There is no guarantee that investors will be purchasing newly issued shares and so in cases of emergency capital requirement by public limited companies, bank loans are easier and safer. The news concerning the share market that the general public got in the last few years were rarely good news. They always saw that people made huge losses due to the downturn of the market and thus they made processions and protested violently. This discourages any new potential investor to even consider putting their hard earned money in the capital market. The older and more religious generation has gone as far as considering share investment equivalent to gambling and thus refrains from such “haram” activities. But can you imagine how much benefited the capital market and the economy of the country would have been, had these people put in their pension funds in the share market? But who is to blame them seeing the state of the market.
My opinion is that the major reason behind the riskiness of the share market is because the fundamental idea of a share has been lost amidst all the impulsive gambling attitude of traders. Nick Leeson, the infamous rogue trader of Barings Bank in England, had said in his book that the market is one giant casino and that is exactly how the investors are viewing it in Bangladesh now. Shares are portions of the ownership of a company. Shareholders forget the fact that they own a portion of a big company and the companies themselves forget the fact that these investors are actually their owners. Both of the parties, managers of the firm and shareholders, should be responsible for each other. So any profit or loss of the company should be reflected in the profit or loss of the investor and vice versa. That does not mean that each of the shareholders should get involved in the operation of the companies. But the financial intermediaries like brokers and investment banks should facilitate each of the parties to act for the benefit of the other. However, such is not the case in reality. I have heard from people who work in investment banks that there have been situations where the stock price of a particular company has risen, though the company stopped production.
The share prices that we see in the market and in the business section of the daily newspapers are determined like the price of any other commodity in a free-market economy. That is through the demand of buyers and the supply of sellers. The most basic theory of economics suggest that when the quantity of a commodity the buyers demand, at a certain price, matches with the quantity the seller wishes to supply at that same price, then that price is determined to be the market price. So if majority of the buyers of Stock A demand its price to be Tk.100 then the seller will have no other option but to supply the stock at Tk.100. And so Stock A’s market price becomes Tk.100. This demand for a particular stock at a particular price is determined by the buyer’s perception regarding the future return and risk associated with that stock. Normally in Bangladesh the perception of buyers is built on past or historical return and risk of that stock. Since the buyers wish to make profit only by selling the stock at a higher price, thus they look at the past market data to try and find a trend of price increase. This is called the trend or technical analysis of stock price.
Now, had the risk and return perception been determined based on the current profitability of the company then the buyers would have demanded a price that was directly or indirectly related to the successful operation of the company. Instead of trying to profit out of a price increase the investors can try to gain from the company’s operational profits paid in the form of dividends. Let the trend analysis be done on the company’s past dividends rather than the past stock price. There is another theory of economics that finance has adopted. It suggests that any asset’s true intrinsic value is based on its ability to generate cash now and in the future. If such is the case then the true value of a share should be its ability to generate dividends now and in the future. And investors should demand price based on the intrinsic or true value of the share. If the price of the share does not reflect the intrinsic value then on what basis are the investors gambling their money? How can making money on nothing but the demand for a piece of paper be productive for the economy?
Dividends will be paid by the company only when they make profit. So if the prices of shares are determined through the dividends then the investors will be closely monitoring the operation of the company. This will keep the managers of the companies concerned as then the way they run the company will be affecting the direction of the stock price movement. This is where the brokers and investment banks can play a big role. Since they are the mediator in between issuer of the share and the investor, they can calculate the intrinsic value of the shares that they trade with the help of the company’s profitability data and educate the investors about them. In this way the investors will be constantly aware of how their money is being used. The tendency of holding shares for a short period of time to realize only capital gain will also diminish and investors will be thinking long term with their share.
There still lies a problem, that the decision to pay dividends is entirely on the company’s management and thus some public limited companies in our country do not pay any dividend even when they are making profits. This discourages investors to look for dividend gains and focus more on capital gains by selling shares at a higher price. Thus the gap between the industrial market and the capital market widens. Government can intervene here by encouraging firms to pay regular dividends and bridge the gap. This way, external factors like political turmoil, tax, and economic environment will not have any direct impact on the demand of stock prices rather they will impact only on the operation of the company and its profit. The intrinsic value calculation of the share will automatically incorporate such external factors. When the intrinsic value of a stock equals its demanded market price then it is said to be at equilibrium. Continuous equilibrium for majority of the shares makes a market efficient and this will boost up the confidence of savers on share investment.
Things are not as ominous as this article may suggest. Investors today are much more educated about the capital market than their predecessors were a decade ago. People understand the importance of the relation between true intrinsic value of the stock and the operational success of the company. Measures like the Price-Earnings ratio, which finds the relation between the earning ability of the company and the price of its shares, have become an important indicator of stock return to investors. However there still exist some big syndicates who try to manipulate the stock prices through their sheer financial power and gambling attitude and a few ignorant investors who fall in their traps. A little bit of controlling mechanism from the governing bodies and more educated investors, guided by professional brokers and investment banks can make stock investments very lucrative and a major contributor to our economy.