How to Invest Profitably in Quoted Companies

INVESTMENT TALK WITH EMMA

Emmanuel Ewumi

(Over 20 years investing experience in Nigeria’s financial markets)

Investment is the deployment of resources in order to make profit. This is the main difference between saving and investment. You save in the bank for interest while you invest to make profit. This is the motive for investment and it is the main reward for entrepreneurship.

In order to make profitable investment in quoted companies, investors should be able to identify the good and bad companies. When a company is bad it is bad, and when a company is good it is good.

These are some of the things to identify a bad company with;

THE BAD COMPANY

1. CULTURE: A company with is bad corporate culture is likely to be a bad company. The company will have underperforming staff, low workers morale, poor customer relations, high labour turnover, low efficiency, corruption etc.
2. COMPETITIVE DISADVANTAGE: A company entering into a market where it has no competitive advantage will not perform. Only a company with competitive advantage in market share, technology, management and service delivery will perform. A pharmaceutical company that ventured into noodles production a few share ago suffered a major set-back due to her competitive disadvantage in that line of business.
3. INCOMPETENT MANAGEMENT: Investors invest in companies based on the past performance and track records of the managers. Incompetent managers are not proactive and entrepreneurial, they also lack focus. A company that has incompetent management is a target for corporate raiders.
4. UNETHICAL MANAGEMENT: It is not advisable to invest in companies that have unethical management, even if the management is intelligent and competent because they will do serious and permanent havoc to their companies. In the long run, such a company will underperform. We have examples of such companies in the banking, insurance, manufacturing, oil and gas sectors of the economy.
5. INDUSTRIES TARGETED BY INDUSTRIAL NATIONS: Industries exposed to completion by industrial nations where the cost of production is lower will not last . Eg. Volkwagen Nigeria, Peugeot Nigeria, Bewac Batteries and companies in the textile industries.

One can only invest in these companies if there is a deliberate government policy to protect the affected industries, as we have in the agricultural and cement production sectors of the economy.

1. OVERDIVERSIFICATION: A company that operates in more than two unrelated sectors of the economy may not deliver superior returns to the shareholders. UAC Nigeria suffered similar fate, before the company was turned around by the former CEO Mr Ayo Ajayi between 2003 and 2009. The turnaround witnessed in the company saw the share price moved from less than N5 to N50.

Over-diversification can also make the management of a company to embark on buying spree of unrelated companies through debt, cash or share issuance.

1. HIGH LABOUR COST: A company with high labour cost will not last. Instead of investing in staff training, bad companies will also poach from their competitors which is a short term and and expensive alternative.

I know a bank that used to pay more than the industry salary, and also offered sign-on fee to poached staff that is now acquired by AMCON and investors’ funds are trapped in the bank.

1. HIGH MARKETING AND PUBLICITY COST: Marketing is very important for creating awareness and visibility for a company’s products and services, but the percentage of expenses spent on marketing should not be too high compared to the industrial average.

A company’s CEO that spends more than average expense on publicity and appearance in the media has something to hide from the investing public. The performance of the CEO and the company ought to speak for them. I am very cautious of investing in companies whose CEOs crave for media hype, when a CEO does a good job in terms of managing his company the media, satisfied customers and the investing public will naturally hype the company. I can name more than twenty companies with flamboyant and showbiz like CEOs who have succeeded in ruining their companies.

1. HIGH GEARING/ LOW LIQUIDITY: Good companies are cash positive with moderate gearing. Any company with a high debt profile is likely to be bad, such companies work for the bank.

When dividend is declared, the ability to pay cash may be lacking. As a cover-up such company sometimes opts for the declaration of scrip, which may compound its dividend payment problems in the future.

1. DECELERATING QUARTERLY EARNINGS: The best way of identifying a company that is likely to have outstanding upward share movement is to look at its account for the previous eight quarters. When there is deceleration that is falling earnings you should be cautious.

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References

1. Seminar Paper on profitable investment in shares by Emmanuel Ewumi.

       2.       Techniques of making money in shares by Festus Akindipe.

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Next week I will write about the good companies.

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Memorable Investment quotes

Honesty is an expensive gift which should not be expected from cheap people. – Warren Buffet