Is buying and selling
shares a futile exercise?
The Sunday Nation
Nairobi,
28 March 2010
Suppose an investor buys some shares of accompany (XYZ Ltd) during an
Initial Public Offer (IPO) at Sh10 each. Three weeks later, he sells
them to me at Sh12 and another three weeks after that, I sell them to
you at Sh15.
If this was a primary IPO where XYZ Ltd was raising money to expand its
business, then the initial Sh10 will go to the company to finance in the
expansion. The Sh12, however, will go directly to the first investor;
XYZ Ltd will not see a single cent from this money.
The investor will therefore make two shillings profit for doing nothing.
Same case for me – I make three bob for simply holding onto the shares
for three weeks. From this, a fundamental question arises: How does a
secondary market for shares (for example, the Nairobi Stock Exchange)
help the economy? Furthermore; why else would you be willing to pay Sh15
for something that you very well know is worth Sh10 if not to simply to
look for an idiot who will pay you more for it?
This issue has disturbed Githinji for some time now and even landed him
into some minor troubles with some players at the Nairobi Stock
Exchange. It is not a peculiarity of shares, however: the real estate
market also goes through the same process.
You buy a plot of land today at sh100,000 and you can easily get some one
to give you sh200,000 one year later – having done absolutely nothing on
the land. These kinds of deals can be futile exercises. What will you do
with the sh200,000 you get from the sale? Will you buy another plot
somewhere else and wait one year and dispose of it at sh400,000? And
after that: will you buy a third parcel and repeat the process?
If that is your plan, then, in my village, they will say that you are
trying to pound water with a pestle and motor (kuhura
maai na ndiri). Basically, you are running round in circles only
making money for the brokers handling you transactions. You are not
adding value to the economy. There would be little difference if you
held onto the first plot for the three years!
Shares are a little different from land in that they represent ownership
in an entity that produces tangible goods and/or services. Therefore;
there is a good chance that it will grow with time. The share purchased
at Sh10 in an IPO may represent, say Sh5 of net assets in XYZ Ltd at the
time of the offer. A few years down the line, it will be worth more than
the Sh5, perhaps Sh15.
This is the reason, I would be willing to pay Sh12 for it today: because
I expect that its intrinsic value (not the market value) will increase,
as long as the company remains profitable in the future. It’s like
buying an emaciated bull, fattening it, and then selling it to the
butchers.
Whether I can get a butcher to pay me a premium price for the fattened
bull depends on how many of my neighbours are doing the same thing and
whether my fellow villagers like tender beef. The same thing applies to
shares: the price in the market will depend on the intrinsic value (how
fat it is) and, perhaps to greater extent, on the number of people
looking to buy it.
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