RIYADH, 13 June 2005 — Much has been said and written about Saudi and other GCC stock markets, I hope that this article sheds more light on the practical aspect of the matter.
What has happened to the GCC Stock Markets in the past 2 years: People both from within and outside the region cannot help but notice the steep increase in stock prices of most companies listed in the GCC stock markets. All stock indexes in most GCC countries increased over 50 percent in each of the past two years, with some exceeding 100 percent or three folds in two years. The Saudi stock market is a leading performer among the bunch and has already topped 55 percent so far this year. With such superior return, there is no lack of investor interest and funds that has dashed to join this outstanding business opportunity.
Why do we buy stocks: Most of us buy stocks because we expect them to increase in price, and hope that we will be able to sell them at a higher price and in the process earn a profit-the difference between the buying and selling price. Some even consider the added advantage of the dividends that many companies pay for their shareholders. Ofcourse it is not a “free lunch”, so against the opportunity of making money there is a risk of loosing part or all of one’s capital. A naïve investor looks at the opportunity only and ignores the risk involved.
Why do stocks increase in price: Basically the stock price of a company increases in price as a result of consistent good business performance, namely increase in revenue and profitabilty compared to similar companies in the same industries. Stock price increase that is based on business performance usually happens gradually and has a long-term lasting effect. History has shown us that there is even a more powerful but unpredictable factor that moves stock prices, namely investors’ sentiment which has direct control on supply and demand of shares.
Why are the stock prices in the GCC markets up? Many factors have contributed to the increase in stock prices like, exess liquidity in the local markets, high oil prices, huge increase in national revenue, government spending on major projects, expansion in the private sector, encouraging and supportive remarks from government officials, good business results of some companies, privatization, oversubscribed initial public offerings among others. Most of the above factors were instrumental in building a positive investors’ sentiment. The effect of having around half of the nations’ population wanting to buy a new IPO, or when an IPO price increases by 10 folds in it’s first day of trading are solid proof of the impact on such issues on investor’s sentiment. Expanding on each of the above factors is important however it is beyond the scope of this article. Currently most GCC countries expect a government surplus this year, the third in a row for some, and the largest is around SR 200 billion in Saudi Arabia. Can this major contributor to the economy and high stock prices last forever?
Opportunity: The above conditions are genuine, and as long as they continue to exist “reasonable stock price increase” can be sustained. Some factors are solid, like excess liquidity, government spending, huge surplus, and they will in a way stimulate and protect any reasonable growth in the stock markets valuations. Other factors like high oil prices, high liquidity, excessive subscription of IPOs are unpredictable and any volatility in them will have its direct impact on the market. The current high prices are not based on business performance particularly that the price earning ratios are very high, instead they are based on sentiment. This positive sentiment boils down to finding other people who are willing to buy your shares at a higher price. The momentum to buy shares among GCC nationals and residents is still building up and there are no signs of slowing down in the short term. Bottomline, there is an opportunity to make a quick profit, maybe another 30-40 percent in the short term, in many GCC stocks or a stock index even for the conservative investor.
Risk: High oil prices have been the main driver that has increased stock prices in the past three years. Oil prices have direct impact on global stock markets. High oil prices have a negative impact on most countries-oil importing nations, and a positive impact on exporting countries like the GCC. There is no guarantee that the current high oil prices can be maintained indefinitely. Political instability, terror incidents, and sabotage create a concern about global oil supply and produces price volatility in oil and in major stock markets. A superior new business opportunity in any GCC country might attract funds and in the process will require investors to dump their shares of companies from other GCC countries. GCC stock markets are driven today by an overwhelming investor sentiment, so what will happen to stock prices if the sentiment changes overnight? What will happen if any of the top 3-4 companies that make up 50 percent of the total market cap in either Saudi or UAE comes up with poor results? The recent correction of 30 percent to 5 percent in the stock markets of Qatar, UAE and Saudi Arabia is a preview of what might happen if the sentiment evaporates.
Under present conditions, most investors are buying GCC shares-companies with little concern about their earning power. At current valuations the PE ratios are very high — close to forty, and accordingly most companies cannot meet the growth-profit expectations that investors have associated with their respective share price. Sooner or later investors will realize that the company shares that they are buying are not “antiques or collectors’ item”. They are investment instruments that have an earning power, an ability to generate revenue and profit. Accordingly the price a share is able to fetch should be related to how much profit it can bring during its lifetime, and not how much others are willing to pay for it. The number of “ignorant people” who are willing to follow the herd and pay any price for anything is finite. Eventually all such people will enter the game-no one will be left to bid the prices higher, and investors will start looking at the potential earning power of a company and assign to it an intrinsic value. This is when a price avalanche will start. Unfortunately it can happen anytime and without a warning.
Conclusion: The current conditions of the GCC stock markets provide an interesting investment opportunity as long as the above conditions are maintained. Chances are that they cannot be mantained idefinitely. The prudent investor should realize that although the opportunity is real however it is engulfed with high risk. The most dangerous part of this chance is for the investor to become victim of his own greed. A sensible way to utilize this unique occasion is to set a reasonable profit target and execute the plan accordingly. Alternatively is to place a stop loss sell order and update it gradually inline with the stock price increase.
(Salim J. Ghalayini, [email protected], is the author of “Stocks for the Practical Investor”. He manages several investment accounts.)
