Investing in stocks – How to make money the smart way on Africa’s stock markets

Six of the world’s ten fastest growing economies are
in Africa. As the rest of the world economy slows
down, Africa is attracting foreign investment on a
scale that has never been seen before. In 2012 alone,
more than $80 billion in direct foreign investment
found its way to Africa (up from only $9 billion in the
year 2000). The continent’s stock markets have
become a popular target for foreign investors looking
for higher returns. In the last few years, African stock
markets have been some of the highest performers in
the world. While foreign and local investors are
exploiting the huge potential for gain in our markets,
many ordinary Africans seem to be blind to the
opportunities. This article will help to open your eyes
to the goldmine in Africa’s stock markets and how
you can successfully exploit it to your advantage...
First, a little bit of perspective…
Because the performance of stock markets generally reflects the
overall health of any economy, it’s important that we take a quick
look at the economic potentials of Africa that make its stock
markets so attractive.
The part of Africa most of the world sees is a continent steeped
in poverty, poor infrastructure, corrupt systems and bad
leadership. While all of these are true, it’s not really as bad as it
looks. For example, poverty in Sub-Saharan Africa is
decreasing rapidly—from 40 percent in 1980 to less than 30
percent in 2008—and is expected to fall to 20 percent by 2020.
(source: Accenture research )
Africa has its flaws but it seems investors find it difficult to
resist the continent’s impressive growth potential. Within the
last decade, the stock markets of eight African countries,
including Egypt, South Africa and Nigeria produced an
aggregate return of nearly 15 percent. This performance clearly
outclassed the returns from the USA’s S&P 500 (-3%) and the
Emerging Markets Index - comprising Brazil, Russia, India and
China (which rose by only 7 percent). This explains why
hundreds of foreign individuals, mutual funds, investment
banks and pension funds are trooping to Africa for a piece of
the action.
So far in 2013, several African stock markets have made huge
gains. Ghana's stock market, though small, is up more than 50
percent, making it one of the world's top performers. Kenya and
Nigeria (both up by nearly 30%) have been making serious gains.
While the global economy is predicted to grow by 2-3 percent
between 2011 and 2020, Africa is expected to grow by 5-6 percent,
making it one of the world’s fastest-growing regions.
How the stock market works… and how you can
make money from it
We don’t want to totally assume that all our readers know what a
stock market is. We’ll go through a quick introduction and take you
through just the basics…
When economies do well (like in Africa), businesses generally
do well and sell more goods and services to satisfy the growing
demand from customers. Most companies are OK with the
increase in business activity until they reach their limits and
need to expand. In order to expand, some businesses will need
more money to lease a bigger warehouse to stock more goods,
hire more workers, buy more equipment or build a new factory.
To get the funds they need to grow, businesses generally turn
to the banks (for a loan) or go the stock market. (photo
credit: nigeriaintel.com)
A stock market (same as ‘stock exchange’) is a place where
shares in a company’s stock are traded (bought and sold) by
the public. When you buy a share of a company’s stock, you
become a part-owner or ‘shareholder’ of that company.
Shareholders are entitled to a share of any profits the company
makes and any assets it owns (such as cash, investments,
buildings etc). Every day, millions of shares are traded on stock
exchanges across Africa. The Johannesburg (South Africa), Lagos
(Nigeria), Cairo (Egypt) and Nairobi (Kenya) stock exchanges are
some of the largest and most active on the continent.
And why would the owners of any company allow the public to
own a part of their business? Well, to put it simply, the stock
market is one of the easiest and cheapest sources of funds for
businesses (except startups ). Of course they could take loans
from the banks but it’s often a more expensive option since
they’ll have to pay back with interest. Bank loans (and interest)
will always have to be paid back whether business is good or
bad; whether the company makes a profit or suffers a loss.
However, with shareholders, companies only share profits
when they make some and there’s really no pressure on them.
Depending on how much risk an investor is willing to take, there
are two major ways you can make money on any stock
market. The first is through your share of the company’s profits
(commonly known as ‘dividends’). Dividends are paid for every
share owned by a shareholder and the amount of dividends a
shareholder receives depends on the number of shares he/she/it
owns. So, an investor with 1,000 shares of a company’s stock will
definitely earn more dividends than another shareholder who owns
only 100.
Most companies distribute dividends to shareholders once or twice
every year. However, there are companies that do not consistently
pay dividends while some others hardly pay at all. Dividends are
usually preferred by people who want a steady and predictable
source of income. Most of these people don’t usually care what
direction stock prices are headed (up or down) as long as the
dividends keep coming.
The second way to make money from the stock market is to buy
shares at low prices, and sell when prices climb high. Just like
selling any property that is likely to appreciate in value (like real
estate), the profit you make is the difference between your buy and
sell price. Most people who make money from the stock market
through this means buy and sell within a short time frame.
Because of this short term mindset, this option often leads to
speculation which significantly increases the risk and return to the
investor. Although there is a huge potential to make big profits
from buying and selling stocks, lots of people get burned every
year ‘speculating’ on the stock market!
7 Things you must never forget if you want to
make money on Africa’s stock markets…
Investing in any stock market is risky and it’s very possible to
make (and lose) a lot of money on the markets. Most investors are
either too ignorant or overwhelmed by emotion and this often leads
to failure. Warren Buffet, the world’s most successful investor
made nearly all of his fortune by investing in companies or the long
run. The seven points we’re about to share with you provide sound
advice that will guide you and help you make the important
decisions that will make you a successful investor in Africa.
#1 - Making money on the stock market requires knowledge, skill
and discipline.
We’re sorry to burst your bubbles, but investing in the stock
market will not make you an overnight millionaire; it’s not a get-
rich-quick affair. Unless you plan to test your luck and gamble
with the stock market, you will need to take the time to gain
knowledge about investing in stocks.
A serious investor should know the difference between a
growth stock and a value stock and know how to calculate the
book value of a share of stock. You should be able to
understand and make sense of a company’s annual financial
reports and statements. You need to know about risk and how
to manage it with a diversified portfolio. Don’t get scared. If
you have the interest, all of this information is freely available
on the internet. Our top recommendations for you are:
13 Steps to Investing Foolishly by the Motley Fool
The Stock Basics Tutorial by Investopedia
A sound knowledge of the stock market is very important
because more than 80 percent of people invest based on a herd
mentality . Many people invest in a particular stock because
their friends, colleagues and neighbours are talking about and
recommend it. Some others buy or sell because the stock
market analyst on television says everyone should. You are
GUARANTEED to lose money on the stock market if you invest
based on herd mentality.
The pattern of success on the stock market shows that only
people who can think for themselves get ahead. Only knowledge
and skill will save you from the herd. Even the greatest investor of
our time, Warren Buffet, advised against following the crowd when
he said: ‘ When investing in the markets, be fearful when others are
greedy, and be greedy when others are fearful .’
#2 – Choose a professional and reputable stockbroker
Stockbrokers are people who buy or sell stocks on your behalf on
the stock market. They usually charge a commission (a
percentage of the invested amount) for this service. In many
developed countries, people don’t really need to trade through a
stockbroker because they can trade by themselves through
automatic electronic platforms. However, most stock exchanges in
Africa require stockbrokers to place trades for their clients. This
makes your stockbroker an important element to the success of
your investing career in Africa.
Before you choose a broker, make sure you do your background
checks very thoroughly. Is the stockbroking firm licensed to
operate on the stock market in that country? Has it been involved
in any scandals (such as fraud) in the recent past? How well and
fast do they execute their client’s buy/sell requests? Do they have
any minimum investment capital requirements for their clients?
How do their commissions compare to other stockbroking firms?
How good is its customer service? Do they send email or text
alerts whenever there’s a transaction on your account? Do they
send their clients periodic account statements? The effort you take
to clarify these points is usually very worth it!
#3 - Only invest money you can afford to lose
Risk and reward go hand in hand. While your intention is to make a
good return on the hard-earned money you’re investing, you must
also remember that things may turn out badly and you could lose
your money instead. Of course, if you’re not willing to take the
risk, you could lock up your money in a bank account and be
happy with any interest the banks offer.
The best way to avoid putting your life’s savings into the stock
market is to allocate, and only invest, a fixed percentage of your
income – say 5, 10 or 15 percent depending on your financial
situation and appetite for risk. If you don’t earn very much, it’s not
a problem. As you earn more, the amount that makes up any
percentage you choose will increase. The key is to limit your
exposure to the stock market by sticking to a percentage. This
discipline will help to ensure that you do not bet (and lose) too
much money.
#4 – Create a diverse portfolio of stocks
In other words, never put all your eggs in one basket. It’s
important that you spread your investment across industries –
banking, technology, manufacturing, aviation etc. Invest in fast-
growing sectors of Africa’s economies as well as the mature
sectors. Spreading your investment across several sectors
helps to minimize your risk and shields you from unexpected
failure from any one sector, industry or company.
Putting all your eggs in one big basket might be a risky
proposition. Maybe you’re thinking a basket like Apple or
Google stocks is worth any number of eggs, right? Well, as
interesting as these stocks seem, nobody can guarantee 100
percent that these stocks will always remain successful.
Especially at this stage in Africa’s economic development,
anything can happen! This is why diversifying your portfolio of
stocks is very important. (photo credit:
ashburnite.blogspot.com)
#5 – Make sure you’re investing, not gambling
The difference between an ‘investor’ and a ‘gambler’ is that one
person (the investor) depends on his/her skill and knowledge of the
markets to succeed while the other depends on hunches and pure
luck. A real investor understands the business of the companies
he/she buys into and the decision to invest comes from research
and analysis. A gambler doesn’t need to bother about these things
and is happy to invest based on rumours, popular opinions and
maybe superstition. In the end, the gambler may make or lose a
fortune but the investor remains successful all the way. Here goes
Mr. Warren Buffet again: ‘Risk is for those who don’t know what
they’re doing. ’ We’re very sure he was referring to the gamblers!
#6 – Set realistic goals and expectations
It’s more than likely that the stock market will not make you an
overnight millionaire. Because stock market prices will always
swing back and forth and it’s common for investors to act
irrationally when this happens, it’s very important that you set out
very clear and realistic goals that will guide your expectations.
There’s nothing wrong with having high expectations about your
investment but you could be heading for trouble if your financial
goals are based on unrealistic assumptions.
To set the right goals, you need to first determine what your needs
are. Do you need steady income from your investments (in the
form of dividends), or are you looking for share prices to
appreciate so you can sell off and make a tidy profit? Remember,
shares of companies with a reputation for paying constant
dividends may not increase as fast as growth companies which
reinvest their earnings into the business.
No matter what your needs are, make sure you set your goals and
stick to them. When the markets start to go ‘crazy’, it’s absolutely
critical that you have a commitment on paper that reminds you of
the reasons you had for investing in the first place.
#7 – Think long term, not short…
All economic indications predict that Africa is on a path of steady
and sure growth over the next 20 to 40 years. During this period,
the stock markets will continue to swing up and down in the short
to medium term while prices generally climb higher. Short term
investors (or speculators as they really should be called) always
try to time the market and make profits from the temporary highs
and lows.
It’s important that you define your investment horizon before you
start investing. How long are you willing to invest for? Five years?
Ten? You have to be clear on this point to avoid any pressures on
yourself. Agreeing a definite timeframe with yourself allows you to
focus on the endgame rather than get distracted by temporary
gains and losses in price movements.
A final word...
For decades, people around the world have used the stocks
markets to invest in other people’s businesses and share in their
profits. As more investors around the world continue to look for
higher returns on their investment capital, Africa presents an
interesting and lucrative prospect given its impressive economic
growth and potential. Although it’s still early days, this remains the
best time for investors to enter the market.