JEDDAH, 18 October 2004 — Modern corporate finance has always been feeding us with those fraudulent statements such as “the objective of a publicly-held company is to create value for its shareholders”. “Value” for you and I, is “cash dividends” and most importantly our share of ownership which includes our “first claim” on the assets of the company.
Another fallacy well hidden in the corporate world, that the corporate managers are “agents” of the owners (shareholders), working day and night for the interests of all shareholders. And let us not forget the role of the board of directors (who are supposedly the guardians looking after the shareholders’ interests) which is defined as a mechanism for preventing the concentration of power in the hands of a small group of top managers and for creating a system of checks and balances in corporations through its “given” authority by shareholders to hire management and monitor their plans, decisions and actions.
Reality has always been different from the various theories of modern corporate finance. Since ownership (by shareholders) and company’s control (by management) are separate by design, a situation that allows management to act in its own best interests rather than those of shareholders. Worse yet, management (in collusion with its board of directors) has successfully reversed that “agency relationship” by assuming the role of the real owners with unconditional control of the company. In reality they hijacked the company, thus, degrading the shareholders to “residual owners”.
When have you heard of an agent mortgaging the company’s assets? Incurring debt? and all along, paid himself a generous annual compensation and still had the audacity to publicly stated that “I work for the interest of the shareholders”.
As for the selection of the board of directors, the whole process of selection and appointment, is initiated and finalized with senior management, then later on, the final menu is presented to the shareholders as a “fait accompli”.
On their first days of business, management commits the ultimate sin against the trust and faith of their shareholders: They add mountain of debts on the company’s books, collateralizing the company’s assets to their friendly bankers, and paying themselves generous salaries and bonuses and other perks. By then, shareholders would have already lost their exclusive right of first claim in their company, and are left with hopes and few prayers.
The measure of true “shareholders’ wealth creation (from stocks’ investing or speculation?) All have to do with the capabilities of the companies to generate cash from their operations, otherwise known as “cash flow from operations”(CFO). A reliable indication for such measure is the excess (if any) of CFO over net income. Since accounting profits are based on simply paper-profits, they are less important than CFO, at least to the shareholders.
In the past two years, something has emerged in the Saudi stock market. That “something” of course, is the Saudi riyals amount of loans extended to investors. There is a strong correlation between liquidity and the current rally in stocks.
The question is: How long will this go on? How long will the Saudi banks continue to feed the stock market’s addiction to liquidity? The answer is simple — as long as this market is mainly dominated by few investors (sharks) with deep pockets, and the continuing absence of rules and regulations that suppose to protect the interests of all shareholders at large. Moreso, unless there are strict law enforcement agencies supporting those rules, those sharks will continue to prey on the whole market.
Very few Saudi investors these days seem to care about value investing. Tadawul trading rooms have mushroomed throughout most banks in Saudi Arabia, fully equipped with few sofas, telephones and market monitors, a set up similar to any hotel in Las Vegas. I believe that the only value of any importance to those investors, is the value that someone else places on a certain stock at any given time.
Only tiny fraction of those shares (as listed in Tadawul) are in trade at given time, despite the significant increase in the number of Saudi investors over the last two years. Stocks became valuable because their prices change, both up and down. If they did not change, why would investors want them? It would be easier to hold cash, but much more of genuine hard work would be required if those people were to invest in real assets such as in commerce, industry or construction projects.
Now, anyone sitting with a market monitor, can see in an instant that a stock’s price has moved from SR130 to SR160. And anyone with any imagination can see that they could have made an extra SR30.
That ‘s usually about the time average investors make their first mistake. Because, as soon as the investor starts looking for a particular stock whose price could rise, he is convinced that the stock’s price is linked to the prospects of the company. But this is true only in the most general understanding of valuation. The recent decline in the stock market (in May 2004) was not caused by any drastic changes in the financial position of Saudi companies.
The question that every investor should ask what the big money, the money that literally moves the market, is doing. And this is where investors will get their first clue about what is really behind value in the Saudi stock market. Most of the time, we will find that the big money is doing the exact opposite of what “the herd” is doing. The big money, the sharks with billions in buying power, will always have their way. And if that means dropping a stock 30 percent or 50 percent, then so be it.
The single most important question the average Saudi investor needs to ask is not whether certain stock will increase in price, but ... who is going to make money? When he knows the answer to that question, he can make fortune.
That is how the richest people in the world make their money. The stock market is a game, pure and simple. And there is only one rule: Money always wins.
(Abdelmenem Jamil Addas ([email protected]) is a professor of financial markets, at the College of Business Administration. He is based in Jeddah.)
