Some of us wants to be financially successful by investing in shares listed in the stock market and probably make a fortune out of it. But, somehow our financial literacy constraints us from achieving such objective. Well, as I indicated in the last week’s article financial literacy is a necessary part of the saving and investment process, and therefore as you map out your action plan for getting there, financial education should be part of that map. In this article I will share with you a few suggestions on investing in shares and portfolio management.
The first thing you need to consider in deciding on whether you are ready to invest in shares is to look at your current financial circumstances. Some of us have goals, which are a good start, but we need to see if we can actually afford the investment required to realize our goals. In other words, you need to determine if you have the spare/surplus cash to make investments in shares.
To achieve that you need to construct your personal balance sheet and seek answers to some important questions to see where you stand.
Under normal circumstances, only once you have paid off all your obligations and paid for all your important expenses and you still have income (savings) left-over should you consider investing in shares. Therefore, first thing you need to consider, is to settle your expenses and pay outstanding high interest debts. This is not a rule but it is a prudent advice because if you have debts that costs you say 20 per cent in interest per annum and if you are to use that money for investing in shares, your shares investment returns should be growing at more than 20 percent per annum so that, at some stage you can sell the share to repay the debts and still remain with some profits. If that will be the case then you are doing very well, but this is often difficult to achieve and thus it is advisable or rather recommendable for you to take a simple approach, which says invest your savings, do not borrow or get into debts trying to make investments in shares – because the moment you do that, that will be speculation.
I know some retail/private individual investors who in some cases take the approach of borrowing for the purpose of investing in shares during Initial Public Offering (IPOs); where they borrow from banks with the speculative motives that after the IPO and share have been listed in the stock market for trading, then immediately prices will go up and they will be able to liquidate their investment positions, pay the debt and retain some profits. In some few cases they are successful and, in many cases, they are not successful.
Having achieved the act of careful analysis of where is your financial position, you then need to have a closer look at your attitude towards risk. This will help you see where you would like to be in the future.
So, what kind of things do you need to look into? Here are some points you need to consider: (i) Age and the time remaining for you to continue working before retirement – as well as how much time do you have to achieve your goals? (ii) Occupation and employment status – do you have job security and a reliable income, or are you self-employed or a pensioner?; (iii) Standard of living – what are your ongoing requirements for an enjoyable standard of living, including personal belongings, holidays and luxury (entertainment) items? Are you comfortable now? Are you able to budget?; (iv) Family and dependents – do you wish to provide for your children and dependents’ education or for other needs?; (v) Need for financial independence – do you have a strong need for financial independence and don’t wish to rely on a pension upon retirement?; (vi) Personal control – how much control do you like to have in managing your financial situation?; (vii) Insurance – do you have adequate insurance against risks to your property, possessions, income and wellbeing?
I suggest you speak to a financial or investment advisor to assess this if you do not have the objectivity or knowledge to do so.
Funding your share investment: If you’re going to invest money in shares, the first thing you need is money. In the paragraphs above I’ve proposed that you consider investing in shares if you have surplus income/savings. However, you may to also note that for some many investors, reallocating their investments does the trick.
Reallocating simply means selling some investments or other assets and reinvesting that money into shares. It boils down to deciding what investment or asset you should sell. Generally, you want to consider those investments and assets that give you a low return on your money. Re-allocation is only part of the answer; your cash flow is the other part.
Your cash flow refers to what money is coming in (income) and what money is being spent (outflows). The result is either a positive cash flow or a negative cash flow, depending on your cash management skills. Maintaining positive cash flow helps to increase your net worth.
Lastly, it is important that you set the right expectations and learn what to expect from the share (stock) market, learn to evaluate and analyze businesses that you intend to invest into. Most of these information and data can be obtained from the companies’ published financial statements; also company news and releases might assist. Historical precedents and information related into it are also things to consider, as it is history tends to repeat itself in the share market.
Macroeconomics and Shares Performance
There are several factors that influence the share price performance and the level of return (capital gain) for investors in listed shares. Key factors are: (1) demand and supply factors; (2) economic variables i.e. GDP, inflation, interest rates and exchange rate; (3) company news on corporate actions; and (4) psychological or market cycle-related factors. In today’s article, we will focus on the economic variables, read on:
A company’s value, return and share price reflect the perception of its earnings and profit flow. If the stock market detects something about a company that may harm its earnings flow, the company’s share price falls. If the stock exchange hears good news about the company — i.e. its current earnings, new innovations or discoveries that have future earnings growth potential, leadership enhancement, etc — its share price rises.
Share prices change because sellers and buyers are constantly reviewing companies’ news and especially its earnings prospects. Out of the two factors that determine a change in share prices – future expectations of earnings and the price to earnings multiples, both of these factors depend on an evaluation from buyers and sellers as they learn more about, and understand the listed companies.
Apart from fundamental performance-related factors, investors are also looking at other market information, including economic news (such as economic growth, inflation, changes in exchange rates, change in interest rates, etc) and political aspects that can cause share prices to rise or fall. In the short term, the share price is also affected by intangible factors such as hype, rumors, and word-of-mouth.
Share prices performance on companies listed in the DSE, like other stock markets, are also influenced by what happens in other markets and economies. If there is a substantial fall in other markets prices and indices, Tanzanian share prices are likely to be under pressure as well, mainly because of foreign investors participation in our market. Foreign investors contribute over 90 percent of DSE trading activities and owns a large part of companies listed.
The stock market activities and performance largely depend on the state of the economy and its activities. Economic conditions directly affect companies’ earnings and earnings prospects. Therefore, economic news is as an important influence on the share market activities and performance. Economic statistics that affect the share market are:
• Official interest rate, dictated by both financial markets and Central Bank
• Inflation rate or the rate of increase in consumer prices
• Rate of growth of the economy — Gross Domestic product (GDP)
• Exchange rate, or how the Shilling fares against other currencies
• The health of other key economies
Interest rates and inflation
Interest rates affect companies’ earnings directly because their debt repayment costs rise and fall with the interest rate changes.
Interest rates determine how much it costs to borrow or what one can receive in an investment. A rise in interest rates increases the attractiveness of fixed interest investments (such as bonds) relative to shares. High interest rates also increase a company’s borrowing cost, it means taking money directly from profit to pay the bankers. Rising interest rates also affect the level of economic activity and consumer spending.
Alterations to interest rates are part of monetary policy, a tool that Central Banks wields from time to time in relation to economic activity. Like any central bank, the Bank of Tanzania lifts interest rates to choke off any stirring of inflation, as a result of bubbling economic activity.
During a period of tight liquidity, interest rates rise increases production costs. Conversely, interest rates fall when there is ample liquidity. People have more purchasing power, which is positive for business expansion and share investment. During these times, interest rates are used as tools for mopping up excessive liquidity.
Inflation simply refers to how much the prices of the goods and services that you buy go up by each year. It is usually written as a percentage. One of the reasons that people invest in the share market is to try and beat inflation.
The stock market dislikes inflation: inflation pushes up costs for companies quicker than it can pass them on to customers, adversely affecting earnings. Conversely, when a central bank believes that economic growth needs to be stimulated or an economic decline reversed, it will cut interest rates.
Historically, low inflation has had a strong inverse correlation with valuations (low inflation drives high multiples, and high inflation drives low multiples). Deflation, on the other hand, is generally bad for shares because it signifies a loss in pricing power for companies.
Gross Domestic Product (GDP) is the value of all goods and services produced in the economy. When GDP decreases, the economy contracts and companies’ earnings fall and when GDP increases, the economy expand, and companies’ earnings rises. Therefore, any prospects of positive economic (GDP) outlook will attract investors in the shares of companies operating in such an economy — but the opposite is also true, prospects of negative outlook in the economic activities will reduce investments in shares listed in such an economy.
The health of the key economies
Foreign investors accounts for about 90 percent of the DSE’s activities and over 60 percent of listed shares ownership. Since economic performance and health of other key economies affecting the domestic stock market, this is a concern. The case of COVID-19 pandemic, the tightening global financial conditions, decline in prices of exports and disruptions of economic activities on the backdrop of adopting measures to manage the spread of the pandemic affects market indices, price volatility and returns for listed securities especially for the kind of our markets which overly depend on foreign investors for liquidity and market activity.