Professor Julius Osemudiamen, fce.
Introduction
The
Capital Market
The
Security and Exchange Commission (SEC)
What
does Shares represents
Central
Security Clearing System (CSCS)
The
balance Sheet
Cash
Flow Statement
Investment
-a practical approach
The belief that the strength of any nation is measured by the value of its accumulated wealth and that the rate at which such investment is financed and accumulated depends on the stock exchange market resilience has been quite popular and remains yet to be challenged. Therefore, the functions of this market in mobilizing funds, and investing the funds in productive projects through the public and private sectors, cannot be overemphasized.
This paper discusses the essential or pivotal roles of Stock Investment in economic development of a nation focusing mainly on the emerging stock markets in Africa. The Investors protection remains the core of the exchange, hence the mechanism for sustaining Investors confidence should not stop at setting and enforcing rules for fair-trading, but should involve a framework for watching the market to see that false markets are not created, among other abuses that erodes Investors’ confidence.
In any economy, there exists a financial system that is usually responsible for regulating the financial environment through the determination of the types and amounts of funds to be issued, the cost of the funds and the use to which the funds are put. The financial system is a superstructure, created on the basis of the real wealth of the community. Financial systems, the World over, play fundamental roles in the development and growth of the economy. The effectiveness and efficiency in performing these roles, particularly the intermediation between the surplus and deficit units of the economy, depend largely on the level of development of the financial system (Aderibigbe J. O., 2004:5)
The term “Capital Market” refers to the network of institutions and mechanism which exist for the initial mobilization and subsequent transfer through exchange of medium and long term funds for the use of productive economic concerns, governments and other users (Anao, 1987:3). According to Pandey (2002:793), capital markets facilitate the buying and selling of securities, such as shares and bonds.
The above definitions, no doubt clarifies the fact that capital markets make securities liquid through facilitating the buying and selling of securities by a large number of investors continuously without incurring significant costs. (Pandey, 2002:794).
THE CHARACTERISTICS OF THE CAPITAL MARKET
i. The presence of the Nigerian Securities and Exchange Commission (NSEC). Basically, SEC is not an operator in the market in terms of buying and selling securities. It is, however, the regulatory body in the market. It chairs the allotment committee with the Nigeria Stock Exchange and the Nigerian Enterprise Promotion Board as members.
ii. The existence of the Nigerian Stock Exchange (NSE). The Nigerian Stock Exchange plays a key role in the floatation of issues. It also plays a pivotal role in the creation of a system which facilities smooth transfer of titles to securities in the capital market. It has a lot of requirement through which it ensures full disclosure of information to potential investors of the basic characteristics of a company intending to go public.
iii. Presence of non-bank Financial Intermediaries. A well established capital market needs the participation of a well developed non-bank financial sector to supply funds to it. Thus, the existence of Insurance Companies, Unit trusts, Investment Trusts and other finance houses help to facilities the development of an ideal capital market.
iv. Sub Markets. For any Capital market worth its salt to thrive, there must be effective demand for, and supply of medium and long term loans; and the supply of and demand for securities.
v. The presence of Specialized institutions. The presence of merchant and development banks help to make the capital market efficient and competitive.
For example, the merchant banks, among other functions, deal in Stock Exchange Securities.
vi. The existence of Brokers and Jobbers. The Brokers carry out their activities as agents for buying and selling securities while the Jobbers deal in their own capacities (representing themselves)
THE FUNCTIONS OF THE CAPITAL MARKET.
i. The capital market offers access to a variety of financial instruments that enable economic agents to pool, price and exchange risk.
ii. Through assets with attractive yields, liquidity and risk characteristics, it encourages saving in financial form.
iii. The capital market plays an important role in mobilizing funds and resources needed for development and offers the forum for implementing its policies relating to stabilization; monetary controls and regulation of the banking system.
iv. Through the Stock Exchange, the market gives long-term lenders the opportunity to convert their holding into cash. It also offers companies which have securities the opportunity to obtain cash without reducing their liquidity.
v. By mashalling savings and making them available to companies and public authorities that need them, the capital market plays supportive role in capital formation.
THE SECURITIES AND EXCHANGE COMMISSION (SEC)
This came into being in April 1978 when it replaced the Capital Issues Commission. The Securities and Exchange Commission, better known as SEC, is at the apex of the capital market. Essentially, it plays the role of the regulatory body in the capital market. Set up by the SEC Act of 1979 and upgraded by the SEC Act of 1988, it is the primary government agency empowered to value all new public companies and determine the price of their shares to be offered to the public.
FUNCTIONS OF THE COMMISSION
SEC is charged with the following functions:
i. Register all securities proposed to be offered to, or for subscription by the public or to be offered privately with the intention that they would be held ultimately other than by those to whom the offers are made;
ii. Maintain surveillance over the securities market so as to forestall, or take steps to reprimand or otherwise punish any persons responsible for the creation or emergence of a false market in securities.
iii. Register stock exchange and securities dealers and the agents of the later with a view to maintaining proper standards of conduct and professionalism in the securities business.
iv. Act as the regulatory ‘apex’ organization for the nation’s stock exchange to which it would be at liberty to delegate a wide range of powers comparable with those delegated to, and the prerogative conferred on any recognized stock exchange under the provisions of the Companies and Allied Matters Act of 1990.
v. Approve share allotments prior to publications and ensure that the spread of the securities is fair and equitable.
vi. Ensure that small investors are given the maximum allotment of shares and that the allotment should not vitiate the active interest of some equity holders in the management of enterprise whose shares are being issued.
THE STOCK EXCHANGE
The Nigerian Stock Exchange started as the Lagos Stock Exchange which was established by the Lagos Stock Exchange Act, 1961. The Exchange is an independent organization controlled by the Stock Exchange Council or Board. However, like other financial institutions, its activities are reported periodically to the Securities and Exchange Commission.
Instruments listed on the Nigerian Stock Exchange include:
i. Federal Govt. Development Stocks.
ii. Sate Govt. Bonds or Stocks.
iii. Commercial and industrial loan stocks and debentures.
iv. Company shares or stocks
It should be noted that the Stock Exchange is responsible for the determination and issuance of existing shares only. The determination and issuance of new shares for new companies is the sole responsibility of the Security and Exchange Commission.
FUNCTIONS OF THE STOCK EXCHANGE
In practice, the Stock Exchange, like other Stock Exchange throughout the world performs the following functions:
i. Provision of a central meeting place for members to buy and sell existing stocks and
shares.
ii. Providing opportunities for raising new or fresh capital.
iii. Providing machinery for mobilizing private and public savings and making these
available for productive investment through stocks and shares.
iv. Facilitating the purchase and sale of securities, to help reduce illiquidity.
v. Through its rules, regulations, and operations codes and practices, the Stock
Exchange protect the public from shady dealings and practices in quoted securities with the objective of ensuring fair dealings.
vi. Acts as a channel for implementing the indigenization Decree by providing facilities to
foreign businesses to offer their shares to the Nigerian public for subscription.
vii.Providing opportunities for continued operation and attraction of foreign capital for
Nigeria’s development.
viii. Facilitating dealings in government securities
A share represents the interest of an investor in a Company. When you buy the shares of a company, you become a member (a shareholder) of that company. Being a member or shareholder means that you share in the profit or loss of the company. Shares in listed companies are traded on the floor of the Nigerian Stock Exchange on every working day of the year.
DIVIDEND
This is the monetary portion of a company’s profits which shareholders get or receive for investing thier money in the company. The shareholders have the right to a share of the profit which is declared for distribution. It is a slice of the profit. A dividend is not a fixed amount. Usually, the directors of a company advise on what they think should be done with the profit made by the company and give their recommendations. Profits are either retained or shared. When shared, it comes in form of dividend and when retained it comes as a bonus / reserve.
Some companies pay dividend twice a year. The first dividend is called Interim dividend and the second is called final dividend.
TYPES OF SHARES
i. Ordinary Shares: Holders of these shares often bear the greatest risk as may or may not receive any dividend depending on whether the company made profits or not. These shares have no special rights or privilege attached to them. They are sometimes referred to as “Equity shares”.
ii. Preference shares: These shares give the holders the opportunity to receive a fixed dividend before others. They also receive their capital back before others when the company is wound up. i.e. when the company folds up.
There are three types of preference shares viz:- Cumulative (meaning that if the company could not pay dividend in one year, it has to be carried forward to another year and to be paid along with that year’s dividend as arrears). Redeemable (meaning that the company can decide to pay off the share holder and take back the shares) participating (meaning that after their normal share of dividend, shareholders can also benefit from additional dividend after ordinary shareholders had been paid.
iii. Deferred or Founders Shares: These shares, sometimes called management shares, are usually held by promoters of the company. The shares, usually of small norminal amount, may carry with it a right to take the whole or a proportion of the profits after a fixed dividend has been paid on other classes of shares.
WAYS BY WHICH ORDINARY SHARES CAN BE ACQUIRED
i. By buying during public offers when the shares of the company are advertised and the general public is invited to subscribe.
ii. By buying through stock brokers or banks in dealings on the floor of the Stock Exchange.
iii. By transfers: Transfers can be normal like when a father gives up part of his shares to his son or brother or brother etc.
iv. By inheritance: That is, after the death of the original owner and documentation done at the court and one becomes an executor to the deceased estate.
v. By right issue: This is also a Primary market instrument that enables already existing shareholder to have access to their companies’ shares at reduced prices.
vi. Trading in Rights: This enables a shareholder who does not take his Right to trade off to another investor for cash.
BENEFITS OF INVESTING IN SHARES
- The investor gains part of the distributed profits of the company in the form of dividend.
- Through bonus or script issues, the holdings of the investor can increase above the original units purchased.
- Capital appreciation as market prices of shares increase.
- The shareholder can attend Annual General Meeting and participate in its deliberations as voting members.
- The shareholder can take the advantage of Right issues to increase his holdings
- Share holdings can be partially sold and the investor retains a holding in the same company.
- The shareholder can use his holdings as collateral to obtain loans from the bank.
- Hedge against inflation.
- Shares are semi-liquid investment that can readily be disposed or converted to cash.
- Used as a base asset in incorporating a new company.
RIGHTS AND PRIVILEGES OF ORDINARY SHAREHOLDERS
- Right to transfer of ownership.
- Right by ordinary resolution to remove a director before the expiration of his tenure.
- Right to replace a director and appoint a new one
- Right to fix director’s remuneration
- Right to ask a director to account for secret profits.
- Right to inspect register of members
- Right to inspect the minute of proceeding of any general meeting.
- Right to receive notice of all general meeting, to attend and vote at such meeting.
- Right to dividend when it is declared.
- Right to receive copies of financial statements of the company and chairman’s statement.
DEBENTURE
Debenture are not shares. They are money lent to the company on which they pay a fixed rate of interest. It is repaid by the company at a fixed date. There are two types of debenture. Viz:-
i) Mortgage Debentures: These loans are secured by the fixed assets of the company. If the company cannot pay the loan and the interest at the due date, the assets have to be sold and the proceeds used to pay the debenture holders.
ii) Floating Debenture: These are unsecured. The assets of the company cannot be sold to repay the loan and the interest.
It is essential to note that;
i) Debenture holders are creditors and not shareholders.
ii) Only shareholders can attend Annual General Meetings.
iii) Debenture holders have to be paid their interest whether the company makes profit or not.
SELLING PROCEDURE
TO SELL SHARE
1. Sign the transferor’s column of a transfer form if share is in certificate form or write a
sales mandate letter if share is in CSCS statement form.
2. A script receipt for the share certificate(s) surrendered will be issued. (Certificate
Form).
3. The broker forwards the certificate(s) to the Company Registrar concerned for
verification. (Certificate Form)
4. If the Registrar finds the certificate(s) and signature okay. The certificate(s) and the
broker’s covering note will be sent to Central Securities Clearing System where the certificate(s) will be demolished and made available to the broker for trading. (Certificate Form).
5. The stockbroker demands a letter of authority to sell from client.
6. after the sale, the stockbroker prepares a contract note and issues cheque for the
proceeds.
BUYING PROCEDURE
TO BUY A SHARE
1. The stockbroker gives an official receipt upon payment of cash or cheque.
2. After signing the transferee’s column of a transfer form, the broker will record the choice of stock, quantity and price limit in an order form.
3. The stockbroker records the order in his purchases jobbing note.
4. Once the purchase is concluded, a contract note will be prepared and delivered to the client.
5. Stockbroker must lodge the details of client’s signature and purchases with company registrars for future verification.
CONTRACT NOTE
Is an important document you receive from your broker and it shows the details of the deal that the stockbroker has carried out for you. Contract note will give details on: (a) Broker Commission (b) Stamp duty that has been incurred (c) Purchases or sales of shares (d) Date of Payment.
INDEX
This measures the magnitude and direction of general price movement on the stock market in an integra calculus of price as a whole. Nigerian index was established on 2nd January 1984 and it is called All-Share Index.
CENTRAL SECURITIES CLEARING SYSTEM (CSCS)
The Central Securities Clearing System (CSCS) came into existence in the capital market on 14th April 1997. It is the clearing house of the Nigerian Stock Exchange.
It operates a computerized clearing, settlement and delivery system for securities listed on the Exchange. As evidence of holding, quarterly stock (CSCS) statements are issued free to shareholders. The benefits of the CSCS include;
To investors:
· Reduces the incidence of stolen or lost certificates.
· Reduces the incidence of late delivery of certificates.
· Reduces investment risk and creates opportunity for speculation in the capital market.
· Ease of stock reconciliation.
To the Capital Market:
· Increases transparency of market.
· Increase market turnover.
· Raises investors’ confidence in the market.
· Encourages more foreign investment.
· Increases liquidity and vibrancy of the market.
FUNCTIONS OF CSCS
· Central depository of certificates.
· Provision of sub-registry for quoted securities in conjunction with Registrars.
· Safe keeping/custodian e.g. Special accounts,
· Issuer of Central Securities Identification Numbers also known as Clearing House Numbers (CHN)
PROSPECTUS
Is an offer document that contains all the relevant information that will inform investor the decision whether or not he can buy the stock. It is a legal document offering securities for sale.
Content of Prospectus for Ordinary Share:
It explains the offer, including the terms, issuer and the following:
- History of companies and nature of business. - Purpose of the offer and use of proceeds.
- Price and amount of the offer - Level of indebtedness
- Particulars of directors - Parties to the issue
- Opening and closing date - Document available for inspection
- Receiving agent (list) - Method of Offer
- Costs and Expenses - Material contract
- Claims and Litigation.
THE PARTIES TO AN ISSUE AND RESPONSIBILITIES IN THE PRIMARY MARKET
Issuing House: it is the financial adviser to the issuing company on the best method to raise funds including required approvals, legal and regulatory requirements, timing and valuation.
FUNCTIONS
- Advise on the structure of the exercise, appropriate financial structures and alternative source of funding.
- Share valuation.
- Preparation of required documentation such as the information memorandum, prospectus and application to the Securities and Exchange Commission (SEC).
- Representing the issuing company before the Securities and Exchange Commission (SEC)
- Co-ordination of efforts of all interested parties culminating in the Completion Board Meeting
- Sale of the share
- Preparation of the basis of allotment.
- Post-issue services by advising on requirements for compliance with post-listing requirements.
The success of the issue is primarily the responsibility of the Issuing House. The company will to a large extent, depend upon the market judgment of the issuing House in carrying out the assignment.
INVESTMENT AND SPECULATION IN THE STOCK EXCHANGE MARKET
Great majority of people who buy securities in the Stock Exchange do so for investment purposes with the hope of receiving good dividends. These people are called Investors. There are others who buy securities at lower prices and reselling at higher prices known as SPECULATION. People involved in these acts are called SPECULATORS.
TYPES OF SPECULATORS
1. The Stag: The speculator buys new shares from companies in anticipation that their prices will rise above the issue prices and then he will sell them and make profits.
2. The Bull: He is a speculator that buys securities with the hope that their prices will rise at low prices. He will then resell them and make profit.
3. The Bear: He is also a speculator who sells securities at high prices with the hope that their prices would have come down by the time he buys them again and make profit.
REASONS FOR FLUCTUATION IN SHARE PRICE
Equity prices don’t just move. They may go up or down as a result of some factors such as:
- Audited reports - Money market rates
- Market hearsays - Government policies
- Politics - Wars
- Unrest - Disasters
- Products of a company - Demand and supply forces
- Company performance - Market information
- Instability in the price of shares - Activities of speculators
- The rate of interest - The rate of fluctuations in the value of money.
PRINCIPLES ON HOW TO IDENTIFY INVESTMENT OPPORTUNITY
- Determine your investment objectives
- Get familiar with government fiscal and macro-economic polices.
- Seek information on the performance and state of the companies you wish to invest in.
- Know why you must invest
- Do not put all your eggs in a basket. Diversify your portfolio.
· Buying and selling of securities (shares and Bonds);
· Helping the investors to plan his investments;
· Securities management (looking after your portfolio of shares).
· Research and advise on investment on which shares to buy or sell and when is the best time to do so.
· They serve as stockbrokers to new issue
· Retainership service for quoted companies
· Provide advice on corporate finance
· Supporting the listing of shares and stocks and assisting the applicant company in all aspects such as giving professional advice and making sure that the company is properly presented to the public.
· The acceptance of client orders and the execution of such orders, against the payment of a commission.
FUNDAMENTAL AND TECHNICAL ANALYSES OF STOCK PRICES
It is very important for a prospective investor to have an in-depth knowledge of the company in which he is investing. Organizations express their strengths and opportunities in figures, presented in balance sheets and income statements. It behoves of an investors to interpret the figure, presented in Balance sheets and income statements, relate them effectively with empirical reasoning and take business decisions.
These are possible through:
1. The Fundamental Analysis Approach
2. The Technical Analysis Approach.
1) FUNDAMENTAL ANALYSIS APPROACH
This is an examination of corporate accounting reports to assess the value of a company. The accounting statement reports from many companies usually contain a tremendous amount of information that investors can use to analyze a company’s stock price. In many ways, financial statements are the story of a company. Financial statements provide shareholders and other interested parties a view of the company’s operations and current positions. There are three primary and interrelated financial statements. The Income statement, the Balance Sheet and the Cash Flow statement.
THE INCOME STATEMENT
This statement summarizes the revenue recorded from the sale of the firms, goods and services and the expenses associated with these sales for the given period. The following information is given by the statement.
· The statement begins with the firm’s total sales earning.
· Gross profit/margin is determined by subtracting cost of the good/expenses directly related to the production of the product or the creation of the service from sales earnings.
· Operating expenses such as administrative payrolls, insurance and other expenses are deducted from the gross profit/margin to arrive at the operating profit.
· Net Income or Net profit equals the difference the operating profit and all expenses associated with non equity finance of the business, such as interest expenses plus any income the company received on its investment.
· The profits of the company are used to pay dividends to its shareholders and pay tax to the government, appropriate for other investments or retained for future growth.
· The Income statement is an important reporting sources to determine the worth of a company’s stock. Without profits, either now or in the future, a company will not worth anything
This is a financial statement that shows the financial position of an organization at a particular date. Thus, it is universally considered as a point estimate of a net worth of a business concern.
The information below describes what the balance sheet should achieve.
· The Balance Sheet reflects a firm’s assets and liabilities for a given date.
· The Balance Sheet is a picture of a company’s financial strength or weakness at any point in time.
· The statement shows what the company owns and how these assets were financed (i.e. borrowed money or investor equity)
· The assets of a company can be attributed to either the company lenders (its liabilities) or its owners
· The shareholders fund is determined by subtracting the firm’s total liabilities from its total assets.
This is an analysis of a company’s sources of cash and its uses of cash.
The cash flow statement summarizes other financial statements. The cash flow statement begins with the net income/profit reported on the Income Statement. This statement presents salient information such as cash generated from financing activity, cash generated from investing activity and movement in cash and bank balance.
A cash flow statement underscores a company’s ability to translate activities into cash and what it was used for. A negative cash flow figure represents an exposure to overdraft facilities if it is capable of putting a company’s asset under strings of undue obligations and could raise issues of survival.
PRICE RATIO ANALYSIS
Price ratios are widely used to assess a company’s current value. A price ratio measures the cost of investing in a company, the price of its stock, relative to the company’s financial performance. The price-to-earning ratio or P/E is the ratio of the stock price to the earnings per share of a company. This is very pertinent when considering sustainable future earnings and the growth potentials.
· The performance for a particular level of income depends on how much has to be invested in order to obtain it.
· The price earning ratio is equal to the number of years earnings needed to cover the current market price.
· If a Company has a higher P/E ratio than another, it may be as a result of any of the following:
Investors expect earning to increase faster than the other
Investors consider the company less risky and on the other hand it can also mean that, the company with lower P/E ratio is trading at less than its intrinsic value given its fundamental it implies that there is room for price appreciation all things being equal.
2) THE TECHNICAL ANALYSIS APPROACH
A moving average concept is employed under this approach. A moving average of price of some stocks is computed for a given period of say 90 days. When the closing price is above the moving average, the index or stock signifies an upwardly mobile stock and vice versa.
INVESTMENT RATIOS
The Investor is Interested in Three Principal Issues:
1) The security of the investment
2) The future value of the investment
3) The future income from the investment.
To this end, the investor uses a number of ratios which explore the relationship between share prices, earnings and yields.
EARNING PER SHARE (EPS)
This serves as a good indicator of the management’s use of the investors’ capital. It is also used to determine the price/earning ratio.
EPS = Profit (after tax and interest)
Number of ordinary shares issued
PRICE/EARNING RATIO (P/E ratio)
The P/E ratio may be taken as an indicator of investor’s confidence as the market price reflects the market’s anticipation and estimation of future returns. The higher the ratio, the more confident the market is that the level of earning will be maintained or improved.
P/E ratio = Market price per share
Earning per share.
RETURN ON EQUITY
This shows that the rate of return after all costs, including tax and interest, have been met on the funds provided by the shareholders.
Return on equity = Net profit after tax and interest
Shareholders’ Funds
DIVIDEND COVER
This ratio provides a guide to the company’s ability to maintain its current level of dividends. Conversely, it also indicates the proportion retained by the company for re-investment.
Dividend cover = Price after tax and interest
Dividends
DIVIDEND YIELD
This compares the dividends paid by the company with the share market price.
Dividend yield = Dividends per share %(percentage)
Market price per share
INVESTMENT – A PRACTICAL APPROACH
Investment in a company especially in shares is a long – term affairs and certain precautions must be taken to ensure that your investment is not lost.
Some of the factors to consider before investing in the company include some of the following:
(i) Management Team
This is very important because there are many bad management teams that are only ready to enrich themselves at the expense of the investors. A good management would not only improve the project of the business but must be foresighted by taking steps that will result in growth, improved staff welfare and good corporate citizenry. So the team that make up the management/leadership team must be considered as individuals, their quality and management abilities and adaptability to changing economic environment would determine to what extent they can take the company to in terms of profit and dividend distributions. Many investors who invested in the distressed banks are still counting their losses till today. Some even died in the process. Be wise!
(ii) Company’s Capital Structure
The level of indebtedness of a company to creditors may say a lot on the future profitability of a company. If the level of debts of the company is very high, the shareholders stand the risk of not receiving dividend as high interest payment which may mean that the directors would not declare dividend. At times, the creditors of the company may opt for liquidation when the company cannot pay debts as at when due.
This puts the investors into a tight corner because of the high risk of loss of investment. Avoid investing in a company who will not put your money at high risk due to indebtedness.
(iii) Dividend Policy
It is wise to know which company regularly pays dividend and which company does not. Afterall, this is one of the primary reason for investment. You must check the dividend policy of the company of your choice. Some company pay dividends on a steady basis. If the dividend policy allows payment of dividend annually you will receive the income you desire but if the dividend policy of the company favours non-payment, then look before you leap.
(iv) Bonus Issue
A company who has accumulated a lot of reserves from capitalized profits over the years may decide to reward their shareholders by way of “bonus” issues (shares that are not paid for). For instance it may be 1:2 which means one free share for every 2 held. It means that if your were having 500 shares, you will now have 500/2 which equals 250 + 500 = 750 units. The additional bonus or free shares is 250. This means your investment has grown by 50 percent.
(iv) Capital growth
You must also watch out for companies whose share appreciate or increase in value regularly. That is capital growth precisely. This is reflected in the daily official list of the Nigerian stock exchange, which is publish by most new papers. A company with high capital growth rate offers investors high capital gains whenever the decision to sell is made. For instance, a share bought at N5 may have appreciated to N10 within a year. The investor stands to make a gain of N5 if he decides to sell at that point. Contrariwise, if the share price slump to N2, the investor will as well lose N3 at that point. You are either made richer or poorer.
(v) Legal position and Taxation
Ensure that the company of your choice does not involve itself in illegal business transaction because this must backfire later. Paying tax annually to the government when profit in declare will also save such a company from the wrath of the constituted authority
(vi) Industry and profitability
An investor must consider which Industry in the economy he or she is interested in. For instance we have the Banking sector, the Food and Beverages Industries, the Agro-allied Industry, the Petroleum Industry etc. Is it the Banking Industry or the Petroleum Industry? It is when this question is answered that the investor can then start looking for a particular company in the industry. We have Mobile Nig Plc. Oando Nig.Plc, African Petroleum Plc, Total Nig. Plc, Texaco Nig. Plc, Afroil, External Oil and Gas. Carefully study their profitability and operational performance before you settle on one.
In summary you can evaluate the performance of a company by asking the following questions
(1) How profitable is the company?
(2) What are its accounting policies?
(3) What is the trend of its profitability? Is it improving, stagnant or up and down?
(4) Is the return on share high, low or average?
(5) Is the level of current assets relative to current liabilities ideal considering the nature of business of the company?
(6) How promptly are creditors of the company paid their money?
(7) Can creditors be conveniently paid without it resulting in downturn of activities in the company?
(8) What are its anticipated prospects? Looking at the turbulent business environment, is it likely to make any meaningful gains in the coming years?
(9) What is the profit compared to other competitors in the industry?
(10) Will it survive any stiff competition?
(11) Are its goals, policies and strategies ideal; current and attainable given the environment it operates?
(12) What is the dividend policy of the company?
(13) What do people say of the company?
A TYPICAL ILLUSTRATION OF VALUATION OF A COMPANY FOR INVESTMENT PURPOSES
FRANK DIOPA NIG. LTD COMPARATIVE BALANCE SHEET AS AT 30TH APRIL 2006
2006 2005
(N million) (N million)
Fixed assets, net 252 224
Investment in shares 32 56
Current assets:
Cash 24 23.2
Accounts Receivable 116 76
Stock 204 132.8
Marketable securities 04 348 - 232
632 512
Shareholders Equity
50% preference shares
N10 per value 60 60
Ordinary shares N0.5 per value 14 14
Retained earnings 214 202
Total equity 288 276
8% Debenture due 2006 200 140
Current liabilities 144 76
Total liabilities and equities 632 512
Industry average for select ratios
Current ratio, 2.5
Acid test ratio, 1.2
Times interest earned, 8.0 times
Debt / equity ratio, 7.1
Average age of receivable, 30 days
Stock turnover, 5.0. times
Market price per share N12.5 N12.5
FRANK DIOPA NIG LTD
P & l ACCOUNT FOR THE YEAR ENDED APRIL 30, 2006
2006 2005
(N, Million) (N, Million)
Sales less returns 940 820
Cost of goods sold 640 560
Gross Profit 300 260
Traveling and selling Exp 80 76
Admin & General Exp. 144 128
Total 224 204
Operating Profit 76 56
Interest Expenses 16 11.2
Profit before taxes 60 44.8
Income taxes (40%) 24 17.8
Net Profit 36 27.0
Dividends paid
Preference shares 3 3
Ordinary shares 21 15
24 18
Profit retained 12 9
Retained earnings 1, April 202 192.0
Retained earnings, end of year 214 201.0
I now complete the relevant ratios for investment decision with recommendation
(i) Primary E.P.S
Net Profit – Preferred Dividend 36 – 3 = N33m
Ordinary shares outstanding = 28m 28m
= N1.18
(ii) Price/Earnings Ratio
Market price per share
Earnings per share = N12.5
N1.18 = 10.6
(iii) Margin on sales =
Gross profit x 100
Sales
= 300 x 100
940 1 = 32%
(iv) Asset Turnover = Sales
Average total Assets
= Average total assets
= 632 + 512 = 572 :. Asset turnover = 940
2 572
= 1.6 times
(v) Acid test Ratio
Cash + Accounts receivable + marketable securities
Current liabilities
2.4 + 116 + 04
144 = 144
144 = 1
(vi) Average collection period = Average Accounts Receivable
Average daily credit sales Average Account Receivable N116 + 76
Average daily credit sales N2 = N96
= 940m = 2.575m
365
Average collection period =
N96
2.575m = 37 days
(vii) Current Ratio = Current Assets
Current liabilities
= N174
N72 = 2.4
COMMENTS
The average collection period of 37 days is not significantly different from the industry average of 30 days but an improvement could be made in this area to avoid bad debt.
The current and acid test ratio of 2.4 and I respectively are in line with the industry average of 2.5 and 1.2 respectively.
In the operational area, sales increased by about 15% over the 2005 figure. A near proportionate increase in the cost of sales resulted in an increase gross profit of 15%.
Earnings per share in 2006 was N1.18. This represents approximately a 40% increase over the 2005 figure of N0.85 and was a result of 40% increase in ordinary shares.
The tax bill increased along with the increase in profit before tax. Investment in shares earned no dividends in both 2005 and 2006.
Apart from the quantitative analysis, we also need to know the qualitative aspects such as the industry the company belongs, the quality of management team (does it possess any skeleton in its cupboards, the public’s perception about the company i.e. public image, adherence to government regulations, among others.
Possible areas for improvement include:
1) Inventory control
2) Credit control
3) Operating cost
4) External investment policies