Revving up the capital market (4)

For anyone investing in the capital market, being informed is important. Particularly for the newbies out there, some basic principles are at play that one should be aware of. As in any market, there are buyers and there are sellers.

As explained in my previous articles, the sellers are the different companies offering shares of their corporations, or equity, in exchange for sharing in the profits of the business through the declaration of dividends to the shareholders.

However, as in all businesses, where there are opportunities, there are also risks involved.

When one invests, this decision is premised on an expectation that the business operation is profitable, and would even be more profitable going forward because of the use of the new equity to fund perhaps an expansion or an acquisition of another company.

It is important to point out that future profitability is not an absolute certainty. So receiving dividends is NOT A GUARANTEE when investing in the stock market nor is it a guarantee that the money invested will NOT ERODE in value which could very well occur if the operations prove to be unprofitable. It is even conceivable that the value of the investment can drop even if the underlying business operations are profitable.

This incongruence could occur if the market price of the equity has decreased because of external, uncontrollable factors such as political or economic turmoil in the country which is what is currently happening.

I am referring, of course, to the DPWH corruption scandal that is threatening to boil over in widespread demonstrations and the recent disclosures by the BSP that we have posted a Balance of Payments deficit of $2.6 billion in the second quarter and a sharp turnaround of a January to June overall deficit of $5.6 billion compared to the surplus of $1.2 billion and $1.4 billion, respectively, for the same period last year.

This dismal economic performance plus the corruption scandal is reflected in the PSE index which as of mid-September is at about the 6,100 level compared to about 7,100 for the same period last year.

On the flipside, if the overall market sentiment is buoyant for whatever reason such as the industry is deemed to be an emerging growth opportunity like AI, an investor can probably sell the shares at the Philippine Stock Exchange for a much higher value even if the business still has to turn a profit.

However, when the investment is in a fixed income instrument, this is essentially a borrowing of a corporation via an offering of their promissory notes, or bonds, using the capital market lingo, with a legal obligation to pay back the principal in full plus interest at some future date. Bonds are also listed in an exchange, Philippine Dealing & Exchange, which enables an investor to sell the bond prior to its final maturity at the prevailing market price.

Again, the market price could be lower or higher than the original issue price depending on the prevailing sentiment based typically on the interest rate scenario at the time of the sale compared to the scenario when the bond was purchased. So the sale could either be at a LOSS, when prevailing rates are much higher than the bond’s interest rate, or at a GAIN, when the market interest rates have moved down.

If an investor will not need to cash in the bond prior to maturity, the investment proceeds will be redeemed by the issuer at par, or in full. Of course, like in any borrowing, if the borrower defaults, then all bets are off. To guide investors however on the ability of the borrower to repay, the SEC requires that all bonds are to be rated by an external rating agency as part of the information that need to be disclosed.

You may wonder what is the relevance of the above to revving up the capital market? Well, our stock exchange of about three million investors is composed mostly of retail investors, about a 98.5-percent share, who are not as financially savvy and tend to generally be speculators who trade based on rumors so the swings in demand are erratic.

The institutional investors take up the balance of 1.5 percent. However, value-wise, it is the reverse.The retail market share is only about 16 percent versus the institutional investors which is 84 percent of total value. Given this market dichotomy, the retail investors can provide the velocity in the market that institutional investors would like to see if there is active buying and selling.

The institutional investors should take comfort that their trades which are likely in large blocks will not unduly distort the fundamentals of the shares they are holding. However, given the penchant of retail investors to speculate, there is a need to provide a more concerted push to enhance the financial literacy of this sector which both the investment industry and PSE can advocate to promote stability in the market.

Until next week… OBF!