MARKET DATA REVIEW : Issuing shares to raise capital, attract investors

The Dar es Salaam Stock Exchange (DSE) is a premier listing destination for companies in need of long term source of capital in our country. As is, most people recognise the importance of the DSE, yet they know very little about it.

People are vaguely aware that the exchange stands at the heart of the financial system and the economy. Many people knows that the exchange can be a formidable force to reckon with when it comes to facilitating economic growth of a society — facilitating businesses and the government to raise public money for financing the growth of business enterprises and other development projects.

As for investors, such as employed people, either directly or indirectly (knowingly or not), do actually invest their savings in the exchange’s listed instruments via collective investment schemes, pensions, retirement annuities, directly through having an account at the exchange, etc.

Despite this, it is also true that the DSE is still seen as a remote and a curious place, like a casino or a gambling and speculative place — as I alluded into in my last week’s article, rather than being seen as something tangible and real in impacting our social and economic development.

Even for policy makers and more active investors, much of the inner workings and operations of the DSE are still a mystery. Sure, many people knows that the exchanges facilitates capital raising, that it has a platform for trading of shares and bonds as well as their settlement, but most often than not, the knowledge about DSE to many of us, stops just there.

And therefore, with the cloak surrounding the exchange, its processes and workings, etc it is important that we invest in growing our awareness about the exchange so that we can shape a different future as far as having a stock exchange in our midst is concerned.

With such an introduction, so, how does the Exchange relate to businesses?

We will respond to this question by asking another question: why does a company issue shares? Why would founders of businesses be willing to share the business profits and business secrets with other people when they could keep these profits and secrets to themselves? The reason is that at some point every company needs to raise money, as capital.

This is normally done in order to expand and/or grow the business such as when the company wishes to introduce a new line of business, a new product or service line, a new branch, etc. To do this, companies can either using internal profits retained over a period of time for the purpose, or can borrow money or raise capital by selling part of the company, which is commonly known as issuing shares. A company can borrow by taking a loan from a bank or by issuing bonds (commonly called corporate bond).

Both bank loan or issuing bonds fit under the umbrella of “debt financing.” On the other hand, issuing shares is called “equity financing.” Issuing shares is advantageous for the company because it does not require the company to pay back the money or make prearranged interest (or coupon) payments along the way. The shareholders normally get dividends and the hope of capital gains. The first sale of a share, which is issued by the private (now changed into a public) company itself, is called the initial public offering (IPO).

It is important that we all understand the distinction between a company financing through debt and financing through equity. When an investor buy a debt investment such as a bond, he or she is guaranteed the return of your initial investment along with promised interest (coupon) payments. This is not the case with an equity investment. By becoming an owner, an investor assume the risk of the company, in case the company is not being successful during a particular period. Just as a small business owner is not guaranteed a return, neither is a shareholder.

As an owner of a company that has issued shares, in which you have invested into your claim on assets of the company is lesser than that of creditors and lenders to the company (business). This means that if a company goes bankrupt and liquidates, you, as a shareholder, do not get any money until the banks and bondholders have been paid out. On the other hand, it is important to remember that shareholders earn a lot if a company is successful.

Why should one invest in shares?

For the most part, as mentioned above, the reason we invest in shares is to achieve long-term goals. History has proven to us that share markets outperform any other investment over the long-term and this a compelling reason to invest in shares.

There are several objectives and reasons why people invest in shares and these reasons are different for each person depending on life circumstances, age and specific needs. Some people invest in shares to obtain capital growth. Others invest to obtain a regular income such as a dividend.

We may invest in shares to obtain both an income and capital growth. Shares offer the potential for both strong capital growth (which are tax free for the case of DSE listed companies and regular dividend income (of which DSE listed companies pay half the tax compared to non-listed companies) and they provide protection against inflation.

So, again why do we invest in shares and what factors do we need to consider regarding the investments we make?

The options for investing our savings are continually increasing, yet every single investment vehicle can be easily categorised according to the fundamental characteristics of safety, risk, and return - which also correspond to types of a common investor objectives. While it is possible for an investor to have more than one of these objectives, the success of one must come at the expense of others. Here we examine these types of objectives, the investments that are used to achieve them, and the ways in which you can incorporate them in devising a strategy.

Safety, risk and return

There is no such thing as a completely safe and secure investment. We can get close to ultimate safety for our investment funds through the purchase of government-issued bonds and bills (commonly known as Treasury Bonds and Treasury Bills) in stable economic systems, or through the purchase of the highest quality corporate bonds issued by the top and larger (Blue chip) companies that dominate their particular markets in the country. Such securities are arguably the best means of preserving capital while receiving a specified rate of return because they are perceived to be low risk.

Investing in shares is riskier than purchasing government bonds, but there is also a greater chance of a higher return because of the increased risk. Taking-on greater risk demands a greater return on your investment. This is the reason why shares have historically outperformed other investments such as bonds or money market instruments.

Over the medium –to- long term, investment in shares has historically had better returns than other investment types. Great proof of the power of owning shares is as was presented in the last few months where some of the DSE listed companies’ returns (capital and dividends) in some cases have gone beyond 20 percent per annum, a growth that is more than twice the GDP growth or inflation rate.

Return (income/dividend)

However, the safest investments are also the ones that are likely to have the lowest rate of income return, or yield. Investors must inevitably sacrifice some level of safety if they want to increase their yields. This is the relationship between risk and return: as return increases, risk goes up, and vice versa.

In order to increase their rate of investment return, and take on risk above that of money market instruments (such as bank deposits and treasury bills) or government bonds, investors may choose to purchase corporate bonds or preference shares with lower investment ratings.

Most investors, even the most conservative-minded ones, want some level of income generation in their portfolios, even if it’s just to keep up with the rate of inflation. But maximising income return can be the main objective for a portfolio, especially for individuals who require a fixed sum from their portfolio every month.

A retired person who requires a certain amount of money every month is well served by holding reasonably safe assets that provide funds over and above other income generating assets, such as pension plans.

Capital gain

So far we have discussed risk and return as investment objectives, and we have not considered the potential of other investments to provide a rate of return from an increase in value, often referred to as a capital gain. Capital gains are entirely different from return in that they are only realised when the security is sold for a price that is higher than the price at which it was originally purchased. (Selling at a lower price is referred to as a capital loss.)

Therefore, investors seeking capital gains are not likely to be those individuals who need a fixed, ongoing source of investment returns from their portfolio, but rather, those who seek the possibility of longer-term growth. Growth of capital is most closely associated with the purchase of shares, particularly growth shares, which offer low yields (dividends) but considerable opportunity for increase in value (emanating from reinvestments of current profits for future value creation and growth).

For this reason, growth shares generally ranks among the most speculative of investments as their return depends on what will happen in an unpredictable future. Blue-chip shares, by contrast, can potentially offer the best of all worlds by possessing reasonable safety, modest income, and potential for growth in capital generated by long-term increases in corporate revenues and earnings as the company matures. Yet rarely is any share able to provide the near-absolute safety and income-generation of government bonds.

Mr Marwa is chief executive officer of the Dar es Salaam Stock Exchange Email: [email protected]