Could these listed companies be classified as foundational stocks?

If you have keenly been following the series on ‘get to know your mutual funds’, you would realise that in each post, the top 5 equity holdings of the fund’s portfolio are highlighted. Interestingly, of the few mutual funds covered so far, there appears to be much similarity in their various top 5 equity holdings. In other words, most of the mutual funds list similar companies as their top 5 equities. Out of curiosity, other mutual funds were also looked into to find out if the similarity trend would remain unchanged. To achieve this, some of the most recent annual reports (where available) of major mutual funds were examined. In all, 19 annual reports were studied, which covered 7 different mutual funds (both equity and balanced funds). The main purpose was to figure out if the topmost equities repeating more frequently in the various mutual funds could be considered as foundational stocks. In doing so, these stocks could become a sort of principal, key or foremost stock picks for investment portfolios. Many would agree, to some extent, that mutual funds are managed professionally by fund managers. Hence, following in the footsteps of these fund managers by replicating some of their top stock picks can be useful.

Why foundational stocks?

Investing in stocks is one of the most proven means to build wealth. However, picking the right stocks from the market can be challenging, especially for the novice investor. One requires a good portfolio mix comprising the right stocks in order to be successful. Just like building a house requires strong foundation to ensure its robustness, building wealth with stocks may equally require careful selection of stocks, in particular, starting with good foundational stocks. A poor foundation can cause your building to tremble or worse, topple down, so do poor foundational stocks can cause to your investment portfolio. Arguably, maintaining strong foundational stocks in your investment portfolio comes with some benefits such as good investment returns. Moreover, strong foundational stocks can somehow protect an investor from the impacts of market falls.

Summary procedure for selecting foundational stocks

As stated earlier, the top 5 equity holdings of seven (7) different mutual funds were compared. The mutual funds were Databank Epack, Databank Bfund, SAS Fortune Fund, HFC Equity trust, HFC Future Plan, CDH Balanced Fund and FirstBanc Heritage Fund. To ensure the use of up-to-date data for decision making, data covering the latest three years (2016, 2015 and 2014) were utilised. The topmost equities frequently appearing in the various mutual funds were preliminary grouped, followed by brief background study of their performances. The table below provides comparison between the top 5 equity holdings of the seven different mutual funds. For detailed (raw) data of the top equity holdings compilation, click on this link: Top five equity holdings of selected mutual funds.

 

Table 1: Comparison of top 5 equity holdings of selected mutual funds

 

Mutual fund

Top 5 Ghanaian equity holdings

2016

2015

2014

1 Databank Epack EGL, FML, GCB, SCB, MAC EGL, FML, GCB, SCB, TOTAL EGL, FML, GCB, SCB, SOGEGH
2 Databank Bfund EGL, FML, GCB, SCB, GOIL EGL, FML, GCB, SCB, GOIL EGL, EGH, GCB, SCB, TOTAL
3 SAS Fortune Fund EGL, FML, GCB, SCB, GOIL EGH, FML, GCB, SCB, GOIL EGH, FML, GCB, SCB, GOIL
4 HFC Equity Trust EGH, FML, GCB, TOTAL, GOIL EGH, ETI, GCB, TOTAL, GOIL EGH, HFC, GCB, EGL, TOTAL
5 HFC Future Plan EGL, FML, GCB, SCB, GOIL EGL, ETI, TOTAL, SCB, GOIL EGH, HFC, GCB, SCB, CAL
6 *CDH Balanced Fund CAL, FML, GCB CAL, FML, GCB Fund was not yet established
7 FirstBanC Heritage Fund Annual report not available EGL, EGH, GCB, SCB, SOGEGH EGL, SOGEGH, GCB, TOTAL, GOIL

*CDH invested in only three (3) stocks.

Observations and analysis

From the table above, GCB bank Ltd. (GCB) occurs 18 times out of the 19 studied annual reports. This is followed by Standard Chartered Bank (GH) Ltd. (SCB) which can be counted 13 times out of the 19 annual reports. The rest, in descending order, are Fan Milk Limited (FML), 12 times; Enterprise Group Limited (EGL), 12 times; Ghana Oil Company Limited (GOIL), 10 times; Ecobank Ghana Limited (EGH), 8 times; Total Petroleum Ghana Limited (TOTAL), 7 times; Societe Generale Ghana Limited (SOGEGH), 3 times. CAL Bank Limited (CAL), 3 times; Ecobank Transnational Incorporated (ETI), 2 times; HFC Bank (Ghana) Limited (HFC), 2 times; Mega African Capital Limited (MAC), once.

In total, 12 different stocks could be found in the top five equity holdings of the mutual funds. However, considering the comparatively low occurrences of SOGEGH, CAL, ETI, HFC and MAC, they were delisted, leaving the rest of the seven stocks as the preliminary group for further studies.

 

Table 2: Preliminary group of foundational stocks

Stock Number of occurrences in top 5 holdings
GCB 18
SCB 13
FML 12
EGL 12
GOIL 10
EGH 8
TOTAL 7

To study further on the above stocks, their historical performance trends were looked into. Simply, two main performance indices were examined- annual returns and dividend yields. It must be noted that stocks with fairly good returns can be indication of investors’ confidence in the companies. Furthermore, while dividend pay-outs provide regular income source, they also signal financial stability of companies. The latest 5-year annual returns and dividend yields of the stocks can be seen in the tables below.

Table 3: Latest 5-year performance results

Company Trading symbol Return, %
2012 2013 2014 2015 2016  Average
1 Enterprise Group Limited EGL 26.3 291.7 -6.9 37.1 0 69.6
2 Fan Milk Limited FML 50.4 86.5 -20.7 40 51.7 41.6
3 Ghana Oil Company Limited GOIL 93.8 43.5 19.1 33.3 -21.4 33.7
4 GCB Bank Limited GCB 13.5 131 13.4 -34.9 -6.1 23.4
5 Ecobank Ghana Limited EGH -6.3 87 35.5 7.6 -8.6 20
6 Standard Chartered Bank (GH) Ltd. SCB -74.7 29.9 36.2 -19.9 -25.2 -10.7
7 Total Petroleum Ghana Limited TOTAL 18.5 N/A 20.6 -16.4 -61.2 -9.6
GSE all-share-index 23.81 78.81 5.4 -11.77 -15.33 16.18

 

Table 4: Latest 5-year dividend yield

Company Trading symbol Dividend yield, %
2012 2013 2014 2015 2016 Average
1 Enterprise Group Limited EGL 3.33 0.00 1.43 1.04 2.1 1.58
2 Fan Milk Limited FML 1.13 0.00 1.71 0.00 1.4 0.85
3 Ghana Oil Company Limited GOIL 2.26 1.61 1.52 0.00 1.8 1.44
4 GCB Bank Limited GCB 3.33 2.94 3.96 8.44 8.7 5.47
5 Ecobank Ghana Limited EGH 8 5.18 5.66 11.27 12 8.42
6 Standard Chartered Bank (GH) Ltd. SCB 26.52 3.14 5.65 0.00 2.3 7.52
7 Total Petroleum Ghana Limited TOTAL 2.81 13.72 1.61 2.25 2.3 4.54

In terms of annual performance, with the exception of Standard Chartered Bank (SCB) and Total Petroleum Ghana Ltd. (TOTAL), the rest of the stocks show impressive positive results. Moreover, their average returns exceed that of the GSE (all-share index) in the same period. Enterprise group limited (EGL) beats the GSE index in 4 out of 5 years. Fan Milk and GCB similarly perform better than the market index in 4 out of 5 years while Ecobank and GOIL both exceed the index in 3 out of 5 years.

For dividend yields, Ecobank Ghana and Standard Chartered Bank lead with impressive average yields of 8.42% and 7.52% respectively.

It may also interest you that five of these stocks had even been commended in an earlier article recently. In the article by Kofi Busia Kyei (a financial analyst), EGL, EGH, FML, GOIL, and GCB were highlighted together with UNIL and BOPP as the few listed stocks that had offered great returns to investors in the past 10 years (Refer to the chart below).

foundational stocks _performance
Figure 1: 10-year return of selected stocks on the GSE Credit: Kofi Busia Kyei (a financial analyst)

Even though the performance trend of SCB doesn’t look so good, the high extent of its occurrence in the top five holdings of the various mutual funds may be due to positive future projections. The fund managers may have realised from their analysis, good earning or growth expectations of SCB, thus chasing its shares. Don’t forget that SCB is one of the few stocks that have recorded impressive returns in the current year so far. In fact, since the beginning of the year, its share price has appreciated by 115.52% as of 8th August 2017. Hence, considering it in our foundational stocks can be worth it. Unfortunately, because of the comparative low performance of TOTAL, in addition to its least number of occurrences in the top five holdings of the funds, delisting it from the group may be helpful for now. As a result, GCB, SCB, FML, EGL, GOIL and EGH can be finally listed as our proposed foundational stocks- six foundational stocks made up of three banking stocks, one insurance stock, one manufacturing stock and one petroleum stock (see Figure 2 below).

Foundational stocks
Figure 2: Proposed foundational stocks comprising six listed companies

Conclusion

The similarities between top 5 equity holdings of various mutual funds gave rise to this write-up. Through comparison and further background studies, six listed companies have been proposed as foundational stocks. These can be useful to investors in building their stock portfolios.

If you’re a new investor deciding on buying stocks from the exchange, you can think of starting with at least, one of these companies. Furthermore, investors who are already trading in stocks may also consider rebalancing their existing portfolio and perhaps buy more of these particular stocks.

Finally, if you’re yet to own shares of these stocks, my personal advice is to begin moderately with the ones that have already attained high appreciation in their share prices. For instance, the year-to-date returns of GOIL and SCB are currently 108.18% and 115.52% respectively, as of 8th August 2017. Even though they still have the potential to continue with their gains, the potential to fall is also inevitable due to the high prices already achieved.

 

Percentage rates of investments: Interpreting them correctly

percentage rates of investments

Percentage rates appear to be popular in many financial publications. We see them in different forms- either positive or negative. As investors, some common areas we find percentage rates interesting are documents that deal with investment returns or profits. Many investors, as well as prospective ones, look out for rates quoted by financial institutions to make informed decisions. Unfortunately, most prospective investors get confused in the interpretation of these rates. Besides the misinterpretation of percentage rates, others naively compare rates associated with different investment categories. Their naivety reflects in the manner they query or make statements such as:

  1. “Which mutual funds have the highest interest rates?”
  2. “Which stocks have high interest rates?”
  3. “The interest rate of Mfund [money market fund] is higher than that of Epack [equity fund]”

One consequence of misinterpreting percentage rates is the disappointment that follows when lower-than-expected returns are made on an investment. During a chat with John (a follower of Sikasεm) a few days ago, I was not surprised when he expressed the frustration he had recently been through. He revealed:

“I nearly cried when 700 cedis in an account yielded only 4.57cedis.”- John Mensah

I understand many more people have had such an experience before. Yes! It is a very painful experience to go through. However, to avoid or reduce the impact of similar painful experiences, it would be worthy to study a few of the percentage rates we usually come across in investment products.

 

Annual interest rate

The most common investment products that make use of annual interest rates are Treasury bills and fixed deposits. The interest rates quoted on the various Treasury bills and fixed deposits are annually-based. That is, the return or profit earned on these investment products, when utilising the quoted interest rates, is for a period of one year (12 months). However, T-bill investments do not always mature in 12 months. For instance, the 91-day and 182-day T-bills mature after three months and six months respectively. Hence, the calculated interests need to be prorated (distributed) for the actual maturity periods. That is three months and six months for the 91-day and 182-day T-bills respectively.

To be clearer on this, let’s go through the sample calculation below.

     How to calculate Treasury bill interest

Let’s assume that you invest GH¢1000 at the current 91-day T-bill rate of 13.4700%,

Now, since the quoted interest rate (13.4700%) is an annual (12-month) rate, the total interest on the GH¢1000, after 12-months, would have been (1000×0.1347) = GH¢134.7

 

However, 91-day T-bill investment matures after three months. Hence the above total interest needs to be prorated for a three-month investment period.

Thus, the real interest to be earned on the GH¢1000 would be (1000×0.1347)/4 = GH¢33.675

Note that 3 months × 4 = 1 year. That is why you see the total (annual) interest being divided by 4

In a similar manner, the annual interest would have been divided by 2 if it were to be 182-day (6 months) T-bill investment.

 

Another means to estimate your T-bill or fixed deposit interest is to first distribute the calculated annual interest per each month and further multiply the monthly interest by the actual number of months the money stayed invested.  Using the same example above, the interest earned per month would be (1000×0.1347)/12 = GH¢11.225 Remember that there are 12 months per annum (year).

Now, since the money is being invested for 3 months (91-day T-bill), we multiply the monthly interest figure by 3. That is, (GH¢11.225×3) = GH¢33.675

 

Annual yield

Annual yield is the annual rate of return on an investment, taking into consideration the compounding effect of any intermediary interest earned. Annual yield is most often reported as the investment return on money market funds (a pool of fund invested in fixed income products). Managers of money market funds, while estimating the annual yield, assume that the funds would remain intact in the account for one year (365 days). For instance, the estimated annual yield of HFC Unit Trust on 10th May 2017 was reported as 20.31%. What this means is that assuming the funds in HFC Unit Trust remain intact from 10th May 2017 to 10th May 2018 (one year), the estimated rate of return would be 20.31%. That is, the value of the mutual fund would appreciate by 20.31%. However, since investors continue to deposit and withdraw from mutual funds, the funds are therefore not expected to remain intact throughout the full year. Thus, fund managers keep revising their annual yield on a daily basis to reflect the changes. For this reason, it may be difficult to precisely calculate the return on a mutual fund (money market) investment over a period.

Due to the effect of compounding, investment returns associated with money market funds may not be evenly distributed over the investment duration. Let’s assume that you had invested GH¢1000 in Databank’s Mfund on 12th May 2017. Annual yield of Mfund on 12th May 2017 was 19.88%. Thus, the estimated return (profit) on the GH¢1000 after one year would be (GH¢1000×0.1988) = GH¢198.8 However, the GH¢198.8 takes into account the compounding effects of intermediary profits that are reinvested by the fund managers. As such, it cannot be equally distributed by each of the 12 months. This implies that if the GH¢1000 stays invested for just six months instead of the 12 months, you cannot expect to earn half of the annual profit.

Once again, let’s go through another example using real historical data.

 

Table: Historical investment value of an Mfund account

Date Mfund value, GH¢ Monthly return, GH¢
30/09/2016 879.41 —–
31/10/2016 894.71 15.3
30/11/2016 912.03 17.32
31/12/2016 928.61 16.58
31/01/2017 945.83 17.22
28/02/2017 958.98 13.15
31/03/2017 971.49 12.51
30/04/2017 988.82 17.33

 

The table above shows the value of an Mfund investment account (a money market fund) over a seven-month period. Based on the investment values, the monthly returns are also calculated by subtracting preceding values from current ones.

Even though the fund manager (Databank) had estimated an annual yield of about 23% at the time, the returns (as seen in the table) were not equally distributed over the period- They differed from one month to another. For instance, November return of GH¢17.32 had increased from the October return of GH¢15.3. On the other hand, the return in January (GH¢17.22) had dropped to GH¢13.15 in February. Factors that account for non-equal distribution of Mfund returns include, but not limited to, compounding effect of intermediary profits as well as changes in interest rates of fixed income products during the investment period.

 

Year to date return (YTD)

Whenever we mention year to date, we refer to the period between the start of a calendar year and the present date of the same year. The beginning of the calendar year often has 1st January as the baseline. Year to date return therefore refers to the return or profit made so far, from 1st January to the present day of the calendar year. For instance, a year to date investment return of 10%, as of 30th April 2017, implies that from 1st January to 30th April 2017, a return of 10% had been made on the investment.

Year to date returns are usually reported on equity-related investment products such as the Ghana Stock Exchange (GSE), Epack investment fund, SAS fortune fund and HFC Equity Trust. Similar to the annual yield explained earlier, year to date returns can drop or increase from time to time within a calendar year. Again, year to date returns do not accumulate in a linear functional manner. In other words, they do not distribute proportionally along the calendar year. The mere fact that a year to date return after the first four months (30th April) was 10% does not necessarily mean that the return at the end of the year (31st December) would be 30%. This is due to price fluctuations on the equity markets. On every business day, equity fund managers recalculate their year to date returns based on the present prices of stocks.

It is also important to note that published YTD returns mostly affect existing shareholders than prospective ones. Now let’s have a look at the scenario below:

percentage rates of investments_scenario

From the scenario above, it is clear that the investor lacked understanding of YTD returns. This is a common mistake many prospective investors make when investing in equity funds. As I mentioned before, YTD returns mostly affect existing shareholders. Thus, the 45% the prospective investor noticed in September 2016 was a profit that had been ‘earned’ already by the existing shareholders of the equity fund. To accurately estimate his return, he needed to do that in reference to September 2016 since that was when he made the deposit. According to the scenario, the fund had lost 5% (45% to 40%) from September to December. Hence, the investor had actually lost part of his deposit.

In a similar situation, an existing shareholder who topped up his account in September 2016 would not enjoy profit on the additional deposit that was made in September. Nevertheless, he would enjoy the 40% return on his previous investment (prior to the deposit in September) if that investment had stayed in the equity fund from January to December 2016.

 

Comparing percentage rates

It is important not to compare percentage rates of different categorical investments. For example, the annual yield of HFC unit trust (a money market fund) as of 10th May 2017 was 20.31%. On the same day, the year to date return on HFC equity trust (an equity mutual fund) was 9.68%. It would be a big mistake to compare these two percentage rates and assume that HFC unit trust performs better than HFC equity trust. This is because the 9.68% return on HFC equity trust is only for the period of 1st January 2017 to 10th May 2017 while the 20.31% on HFC unit trust is a 12-month estimated rate.

On another note, it may not be appropriate to compare the year to date (YTD) returns of two different equity funds in the early part of a year. As stated earlier, YTD returns do not distribute proportionally along the calendar year. For instance, the YTD returns of SAS fortune fund and Epack investment fund, as of 11th May 2017, were 14.51% and 5.4% respectively. While the rate for SAS fortune fund is higher than that of Epack, it may be premature to conclude that SAS fortune fund performs better than Epack investment fund. This is because the YTD return of SAS fortune fund may drop while that of Epack can rise steeply before the year ends. Thus, a more appropriate comparison could be done at the end of the calendar year.