Investing in the stock market

Stock markets refer to the actual market and the activities of listing and buying and selling of shares. It is the market where companies are coming to the exchange and investors are coming to the exchange for mutually beneficial reasons, the companies to raise capital and the investors to buy stocks and get a return. 

One of the most important requirements to facilitate this is a vibrant stock market. A vibrant stock market is key to an efficient and successful stock market.

Why is it important and how does it benefit you as a potential investor? 

• A vibrant stock market assists with price discovery and ensures that the stock is coming to the market at the right prices. 

In a primary transaction, that is, the initial transaction, the company goes to the investing public, through the Exchange to offer their shares for sale - this is referred to as the IPO or the Initial Public Offering.

The price of the share that comes to the market at an IPO is normally set by the investment banker that is determining the current price to come to the market, so it is predetermined and is set as the price that the company comes to the market with as an IPO share price offer. 

However, once the IPO is done and the shareholders have bought into the share then the secondary transaction market gives you valuable insight into market pricing.

Secondary transactions are therefore referred to as the stock market which is the buying and the selling of the shares on the Nairobi Securities Exchange and it is based on competitive buying and selling because there has to be an interaction of the price that the buyer is willing buy and the seller is willing to sell.

So how does a vibrant competitive market in an IPO assist market pricing? If an IPO comes to the market with a pricing that is deemed to be overpriced, it means that the market will not buy into that IPO and this means that the IPO would be undersubscribed and will not be considered to be a successful IPO.

If, however, the company comes into the market with a very good price, the investors will take up the shares which will result in a fully subscribed offer where all of the shares are taken up or even an oversubscribed offer where the shareholders actually want to buy even more shares than is available. This, therefore results in a successful IPO. 

Companies are often faced with the challenge to come up with a competitive pricing and the market helps them to ensure that they enter the market with a competitive price. Therefore, it is important that the market price of an IPO be right. 

• After investing in different ways and strategies, all investors look for a return, depending on the investing strategy that they undertook. In light of this, all investors require a vibrant stock market that allows them to buy and sell at will. A vibrant stock market allows savvy investors to take advantage of opportunities and buy when their assessment of the stock is undervalued and sell when the market price comes up to their value. 
• A vibrant stock market attracts activities among shareholders, which in turn attracts companies to come to that market for equity capital rather than looking for debt. A vibrant stock market talks to the companies' willingness to do corporate actions and corporate actions are where investors can further benefit from their investment.

How does an investor benefit from Corporate Actions?

Dividends is one way of making a return on a stock market investment, but there are other ways that an investor can make their returns and these are through corporate actions that are made possible by a vibrant stock market. For example;-

1. Bonus issues. 

In this corporate action, a company may have high retained earnings and they offer a bonus issue to shareholders. The shareholders get the benefit of additional shares at no cost. Just by being an existing shareholder, they benefit from the bonus shares.

Bonus shares are usually offered as a factor of existing shares e.g. a two-to-one bonus offer may mean that for every two shares you hold as a shareholder, you get one additional share at no cost.

2. A company may offer a rights issue. 

In this corporate action, a company is going to the market for capital reasons but they are offering rights issues to existing shareholders. Therefore, they offer their existing shareholders the right to buy into a new share offering at a discounted price. 

Rights issues are additional shares coming to the market that do not affect the existing shares that shareholders have. In this case, a shareholder can benefit from this corporate action by taking up their rights allotment and actually buying these additional shares at a discounted price knowing that once the shares are listed, the market will take it back to the higher market price or, they can sell their rights in the market to another shareholder who wishes to buy into the rights issue but cannot participate in the rights issue because they are not existing shareholders.

3. Another corporate action where a shareholder can benefit is a split issue.

Sometimes if a stock price is too high in the market it will affect the liquidity as the higher the stock price, the lower the ability of the retail market to buy those shares so a company may decide to split or do a stock split.

This can also mean that the company is thriving because they are having a very high market valuation so by splitting the price they are allowing more shareholders to come in and are reducing the value of the share.

When a stock split is done, it does not affect the underlying value of the share it just means the per share is split because one stock may be split into two so the power value and the price will differ but for existing shareholders, they still have two stocks that add up to the value of their original stock so they do not lose. However, new shareholders have more ability to come in and therefore more ability to buy an active trade-in. 

4. Companies offering shares for cash as dividends

In addition to offering the option for a shareholder or investor to take that dividend as a cash dividend there’s also the option for them to take a SCRIP dividend When companies issue SCRIP dividends, it means they are giving investors the option to receive additional shares instead of a cash dividend which means they will take shares instead of cash. 

What strategies are available to an investor looking to get into the stock market?

The following are all different strategies that investors can take up depending on their comfort, their ability or their knowledge but regardless there’s the ability for every investor to get into the stock market.

An investor’s strategy may change over time as they become more conversant with the market but from the savviest investor to a beginner investor, there is a strategy for all. Some of the common strategies are;-

Buy and hold- also called position trading, is an investment strategy whereby an investor buys financial assets or non-financial assets such as real estate, to hold them long term, with the goal of realizing price appreciation, despite volatility.  

Invest for Income strategy – Income investing is all about making investments that produce consistent income, either through dividends, interest or a combination of the two. A company that pay good dividends at the NSE include Standard Chartered, British American Tobacco, Absa Bank Kenya etc

Dollar-cost averaging – here the investor aims to have a diversified portfolio and puts aside a certain amount of money to invest at regular intervals that he or she invests equal amounts across various companies and industries regardless of the price using a predetermined amount and time period to invest but the key is to have a diversified portfolio.

On average, they will have a balanced return, some shares you may hold less because the price is higher, and some shares may hold more because the price is lower  but the portfolio is diversified 

Growth investing- here, the investor looks for companies that have signs or potential of above-average growth or even smaller companies that have the potential for growth. This is a riskier strategy as it needs an investor that is able to assess and review the company’s financials to identify those growth companies.

The potential for this kind of strategy is quite high but on the flip side, the potential for losses can also be high if the assessment is incorrect, for this reason, this really needs a confident investor who is confident in their ability to review market information.

Bargain Purchasing – here the investor looks for shares that are selling at low par value, due to a catastrophe or event, but the investor is confident that the company has the ability to turn the event around and that the share will eventually come back to the previous market value.

At this point, the investor buys when the share is undervalued knowing that the company is able to come around the catastrophe or event that caused the dip, and as a result, the investor will then have a share at a higher price. Some of the most common measurements used to determine if a stock is undervalued or overvalued is looking at the price-to-earnings ratio which is found by dividing the share price by its earnings per share and the earnings per share is found by dividing the company’s profits by its outstanding shares. This information is readily available on the Nairobi Securities Exchange website.

So buying into an undervalued share is where savvy investors buy when the market is depressed or when there is a bear market. One key to this strategy is that the investor has to correctly assess whether the company involved will be able to overcome what is causing the dip in share prices and go back to its normal market pricing.

Stocks can be a valuable part of your investment portfolio. Owning stocks in different companies through Apps like the AIB DigiTrader mobile App, is a simple process, but can help you build your savings, protect your money from inflation and taxes, and maximize income from your investments.

Although stock investing has several benefits, investors must also be cautious while making their decisions. Understanding the stock market basics and doing their research before investing is advisable to mitigate risks and maximize returns.