By James Abola
If you want to make money in an honest manner, there are four things you could engage in. You could get a job and earn a salary or wage; you could become self employed; you could own a business or become an investor. While most people think of finding a job or starting a business few people think about investment as an alternative.
One possible investment place is the securities market like the Nairobi Stock Exchange or Uganda Securities Exchange. Perhaps we shall have a Kigali Securities Exchange or an East African Securities Exchange in the near future.
The major items traded on the securities exchange or market are shares and bonds. Shares and stocks are the same, only that Americans prefer stocks while the British use shares.
Shares represent units of ownership in a public company. In the case of
Bonds on the other hand are basically a chance for the investor to lend money to the government or a company.
The investor receives interest and the principle back over predetermined amounts of time. Bonds are the most common lending instruments traded on the market. I will spend more time on shares because they are more suited to a small investor as compared to bonds.
The simple reason is that to make a meaningful trade in shares on the Uganda Securities Exchange or Nairobi Stock Exchange requires a minimum of about Frw160,000 while just one unit of a bond requires principle payment of about Frw3.1 million.
The beginning of trading in shares is the Initial Public Offering (IPO). An initial public offering (IPO) is the sale of equity in a company, generally in the form of common shares, through an investment banking firm. These shares subsequently trade on a recognised stock market.
Usually during the IPO companies want to avoid a situation where there will be less demand than the number of shares offered, so the IPO price is set low enough to generate enough or even excess demand for the offered shares and to avoid the winner’s curse. In most cases therefore shares offered at the IPO are sold at a discount.
While history indicates that share prices appreciate, in many cases very substantially, after the IPO it is important to know of what is often called the winner’s curse.
The winner’s curse is a financial theory that the winning participants within an auction will typically pay an overvalued price for the winning item.
The problem of the winner’s curse occurs during any auction process when bidders must estimate the true or final value of a desired good. Generally, bidders are considered to be risk averse and the average bid is expected to be lower than the final value.
However, due to estimation errors, the winning bid is usually much higher because the highest overestimation made by any of the bidders will win the auction.
One man told me that he would never buy shares of African companies because they do not pay dividends. A dividend is just one of the two major gains that a shareholder can receive. A dividend is similar to interest in that the company you have invested in pays out money to shareholders in accordance with the number of shares held.
Dividends can be paid in cash or in forms of additional shares also known as bonus shares.
Another important gain derived by a shareholder is the appreciation in share price.
Take the example of my friend who bought shares of a company and a few months later the price had about doubled. Even if my friend did not get dividends he could sell his shares and have twice the amount of money he paid when he acquired them.
Many countries have found the floating of shares to be a good way of providing investment opportunities to their citizens. So instead of having 100 per cent state controlled parastatals, 60 per cent or even 80 per cent of the company is offered to the public.
This results in true national ownership where citizens can gain when the share price goes up or when the company pays dividends.
James Abola is a business and finance consultant.