Karachi Stock Exchange Stellar Performance; A Green Pasture or a Deadly Moat?

 

Karachi stock exchange has performed surprisingly well in the current year also. The annual report released last year said that KSE 100 index yielded return of 29 % which was highest amongst regional markets.  The strange thing is that Pakistan’s economy cannot be compared to anything with developed world. Pakistan as a country is marred by excessive shortage of power and energy which has resulted into long shut downs of power and unavailability of gas for the production units. On the scales of power consumption per capita Pakistan ranks with the lowest countries in the ladder with just 450 Kwh consumed per capita.  

Contrasting these facts is the pleasant performance of our stock market that has been giving out returns which were in access of the stock markets from the developed world including NASDAQ   which gave a return of 25% for the same period. If we compare other stock markets like Singapore, Jakarta, Vietnam, and India with Karachi stock exchange, its performance can be ranked amongst the top tier.

This apparent anomaly has kept everyone thinking about the reasons behind the great rally. “The Economist” considers that the strong performance is partly due to improving conditions in Pakistan, including a reasonably free and fair election followed by a peaceful handover of power. The slowing down of the BRIC economies has also driven investors to try out ever more unusual markets. Some reasons as indicated by KSE itself are strong underlying corporate earnings’ growth and de-leveraging. Another reason is “attractive valuations” as the market capitalization-to-GDP ratio is also very low.  

Stock exchange has been seen as an institution which helps any economy in raising capital for its businesses; existing and new. KSE has a market capitalization of above 6 trillion Rs.  The number has jumped astronomically in the last one year and in the analysis of “The Economist” it is due to the amnesty passed in January 2012. The authorities affirmed that from that date, investors would be allowed to buy shares with no questions asked about where their money came from. The remission, which is due to last until June 2014, is designed to nudge people with undocumented funds to invest them in the market, thus bringing the cash into the formal economy. This has worked it appears. The average daily volumes traded on the KSE have more than doubled after this scheme was announced. This means that KSE managed to induct quite a lot of money from the undocumented sector to the documented realm. By some measure this is also a way of capital formation as it is only the white money that can give rise to corporate capital and new projects.

Stock exchanges always have been a target of a lot of ridicule lately. There was a lot of mayhem in front of the Wall Street in the last year with occupy Wall Street activists and also Wall Street has not been saved from the fun that has been made out of it. On a lighter side I think we refer to Warren Buffet. Today, Buffett's personal net worth is around $55 billion and his investment firm, Berkshire Hathaway, owns a number of prominent American companies including: GEICO, Dairy Queen, Fruit of the Loom and Helzberg Diamonds. Buffett's annual letters to Berkshire Hathaway shareholders are highly anticipated; his writings are widely lauded for their effective storytelling and clear, simple language. So the quote: “I never attempt to make money on the stock market, I buy on the assumption that they could close the market next day and not reopen it for five years.” I think this is good quotation but it has a lot of wisdom that Warren Buffet has put forth in a lighter manner. Stock market should not be viewed as a place where quick buck can be made although this is what a lot of individual investors try to do as they come to the stock market. There was another good quotation which said “United States has developed the new weapon that destroys people but leave buildings standing, it is called stock market.”

If we look at these few quotations stock market is seen as something which does more harm than good to a lot of people that’s why we look at these of kind of funny quotations. A very important thing we will deal with in this article is the way normal investors have been understanding the markets and how they should rather look at it. The focus of this article will be on the question whether general investors have made similar kind of money while investing in this market. Have they benefitted to the same extent or again the market has outsmarted them.

 William Bernstein said "There are two kinds of investors, be they large or small: those who don't know where the market is headed, and those who don't know that they don't know. Then again, there is a third type of investor -the investment professional, who indeed knows that he or she doesn't know, but whose livelihood depends upon appearing to know."

An important factor is that it is very difficult to predict the future earnings of a company without going through the data and second it is further difficult to predict the market price.in the spectacular rise of the stock market in the last one year and so if you see the stock market has consistently turned all the analysis upside down by way of its own performance as compared to the economic data. Let me  give you some examples  here, CPI  in November 2013 was higher than expected at 10.9 % YOY, foreign exchange reserves have been skipping downwards by that time they were close to 8 Billion dollars only and there were troubling news  on account of foreign exchange receipts by virtue of the funds that were expected from the privatization of PTCL. Further there was troubling news with respect to the targets that were suggested by the IMF with regard to fiscal deficit.  Data on General Economic Front did not present a very rosy picture. If you couple it with the energy shortfall which was almost to the tune 5500 MW and the shortage of natural gas in the system there by making it impossible to run the industries. Further on top of it the problems of gas with the fertilizer sector which would impact the availability of urea and further down the line prices of fertilizer having it negative effect trickling on agriculture.

With all the above in formulating the general scenario the market performed remarkably positively. If you look at the various analysis and recommendations by the research houses of the top brokerage houses in Pakistan we saw that a number of stocks were breaking the upper level expectations of the analyst. Just given an example there were recommendations about the PPL having a target price of 236 in October in various research reports and that time the stock was trading at 195 but in November we saw the stock climbed up to 290 a share. So the market has a mind of its own! Proved once again here!

We can compare some research reports and calls by various research houses for 2013 with the actual year end market prices and earnings of a few companies to understand how right or wrong the forecasts hold against the real results.  We compared the research paper of a leading brokerage house with the actual results, for Fauji Fertilizer the call was buy with a target price of 136, actual Dec end price was 112. Likewise Nishat Chunian power target price was 25 but it achieved Rs. 34.78 by the year end. However the target price matched the actual year end market price for PTCL that was trading at Rs. 28.44. We can go on and on in this comparison and find similar kind of very mixed results with a majority of mismatch between the target prices and actual results.

This puts all those investors in a lot of confusion who look at the research reports and tend to take recommendations by the analyst very seriously. They use this data to make their investing decisions based on recommendations   of buy, sell and hold by the renowned research teams of leading brokerage firms.  This mismatch between the research and the actual can be captured in a very good quote that appeared in an article “All of this shows that the market has mind of its own and most of what is taught about investing in business schools is theoretical nonsense. There are very few rich professors.”   

All this shakes the confidence of the ordinary investor as to how he should understand the recommendation which he reads in the research reports or which he listens from the analyst by virtue of seeing  them on the talk shows or taking advice directly.  In a recent research which has been published by Dean of Harvard Business School, Nitin Nohria along with Boris Goryseberg, Paul Helay and George Cerafem; they tried to look into this. They surveyed one thousands analyst in Asia, Europe and America asking to them to rate one thousand large companies on twelve factors on a scale of one to five  and forecast revenue growth and gross margin on the basis of the ratings assigned by them. They found out that the strongest determent of the buy and sell recommendations by any analyst was “projected industry growth” which was followed by “the top management team”. But the commonality in the analysis tends to fade ahead of this as there were quite a lot of differences.  First of all the analysts in the survey differed in what kind of weight they assigned to various factors. For example “a very well communicated strategy” was very important thing with the US and European analysts but it was low importance to the analysts of other regions. Likewise the importance of the “governance” was rated much higher by the US and the European analyst as compared to Latin America and Asia. This signifies that analysts are analyzing based their own tools along with their on biases and understandings of the sector and also based on the relative weight which they place on various factors. Ordinary investor has to understand some what the mind of the analysts before following them blindly.

I have come across a number of investors who are happy in investing in individual shares but they tend to shy away from investing in the market through the mutual funds. There can be many reasons for that which is not the scope of this article but it appears that actively trading in individual scrips has some kind of thrill attached to it. This dose of adrenaline is not available in the boring method of taking up some units in a fund and then divesting them after a long time. Although if someone has done that by investing in a fund that represents the whole market (Karachi Stock Exchange) , he or she would have made a killing just by tracking the performance of Karachi Stock Exchange.

For the individuals a right strategy to make money from the magnificent KSE would be to follow some pieces of advice from Warren Buffet. Using excerpts from an article by “Schuyler Velasco” of Christian Science Monitor:

·         “It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”  This is one of Buffett's more famous quotes, and it reflects one of the basic tenets of his investment strategy: He sticks with companies he can fully comprehend, and ones for which the intrinsic value is self-evident, regardless of the current state of their finances. It's a philosophy that has served him well;

·         “I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will.”

·         “The stock market is a no-called-strike game. You don't have to swing at everything – you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, "Swing, you bum!"

·         “Price is what you pay; value is what you get. Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down.”

·         “Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.”

·         “If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety.”

·         “'We've long felt that the only value of stock forecasters is to make fortune tellers look good. Even now, Charlie Munger and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”  Charlie Munger is Buffett's longtime business partner and the vice chairman of Berkshire Hathaway.

Karachi Stock Exchange has emerged as a darling for the investors and without doubt its performance has dazzled the local and foreign investors both. But more often than not the individual investors follow rumours and botched assessments mostly based on nothing concrete and professional. This leads to destruction of value and loss for the individuals.  If the individual investors follow sound advice and invest properly instead of following leads based on speculations or emotions, they would be able to ride the crest of this wave of profitability and returns.

 

(The writer can be reached at kashifmateenansari@post.harvard.edu)