The GSE Composite index may be probably sounding like a noise in your ears very often. You hear about it on the radio, on the television set, in the prints, as well as on the web. However, have you actually spent some time to think about what it really is and how you can put it to good use? If you’re yet to do so, then this write-up can provide you with useful information on the Ghana Stock Exchange composite index and the benefits it can offer you as an investor. In this post, I also briefly cover other related stock indices for background understanding.
Brief background of stock market index
Stock market index is a figure used to measure the overall value of all stocks or selected number of stocks on a stock market. Usually referred to as stock index, it basically provides an overview of how the stock market or a section of it performs. For smaller stock markets with less number of listed companies, the stock index can be calculated for the entire listed stocks. However, stock indices for larger markets are mostly calculated for selected listed companies on the exchange. Generally, it would be difficult to continuously monitor the performance of every single stock listed on a stock exchange. It becomes much difficult as the number of listed companies keep increasing. To make this easier, a sample of the listed companies can be used to represent the entire stock market.
A stock index is calculated from the prices of stocks that the index seeks to measure. For example, an index that aims to measure the performance of all listed companies on an exchange would be calculated from the prices of all companies listed on the exchange. In the same manner, an index measuring the performance of only manufacturing stocks would be calculated from the prices of listed manufacturing stocks.
Globally, it is common to hear of different and variant forms of stock indexes. Some of the popular stock indices are NASDAQ 100 (on the NASDAQ Stock Market), S&P 500 (on the New York Stock Exchange [NYSE] and NASDAQ Stock Market), FTSE 100 (on the London Stock Exchange) and Dow Jones index (on the NYSE and NASDAQ).
Stock indices on the Ghana Stock Exchange
There are two (2) main stock indices currently used by the Ghana Stock Exchange. These are the GSE composite index (GSE-CI) and the GSE financial stock index (GSE-FSI). The two stock indices have been in place since 4th January 2011. Whereas the composite index measures the performance of all listed stocks, the financial stock index measures the performance of financial stocks (banking and insurance sector stocks) on the market.
Besides the above two indices by the GSE, a few corporate organisations in the financial sector have set additional [specialised] stock indices to track certain industrial sectors of the stock market. Strategic African Securities Ltd. (SAS), for instance, utilise their SAS manufacturing index (SAS-MI) to measure the performance of listed manufacturing companies. Similarly, FirstBanC Financial Services employ their FirstBanC index to track their preferred selected stocks.
The GSE Composite Index
The GSE composite index is a weighted index. What it means is that the contribution of each stock to the index is not equal but depends on the market capitalisation of the listed company. In other words, the contribution of a company to the GSE composite index depends on the value of all its stocks listed on the Ghana Stock Exchange. Companies with high market capitalisation contribute much to the index than those with less market capitalisation. Note that market capitalisation of a company is given by multiplying its stock price by the total number of its listed (outstanding) shares.
How GSE composite index is calculated
Calculation of the GSE Composite Index takes into account all listed stocks (ordinary shares) on the exchange with exception of stocks listed on other stock markets. AngloGold Ashanti (AGA) and Tullow oil are examples of companies that have some stocks listed on other stock markets apart from the GSE. As stated earlier, each stock contributes to the index according to the volume and value of its traded shares. The GSE Composite index is therefore based on the weighted average returns of all listed stocks.
Basically, all indexes must have a base or a foundation to be measured against. For this reason, the GSE fixed 31st December 2010 and 1000 points as the base date and base index respectively for the GSE composite index. The base index value was set arbitrarily as the starting value for the index. All later index values can then be compared against the base index to estimate the overall performance of the stock market. For example, the annual return of the Ghana Stock Exchange in 2011(exactly one year after the base index had been set at 1000) was -3.1%. To arrive at this percentage figure, the GSE composite index of 969.03 points recorded on 30/12/2011 was compared against that of 31/12/2010.
That is, GSE return in 2011 = [(969.03-1000)/1000] × 100
Historically, the highest points the GSE composite index has attained so far is 2458.11, recorded on 6th September 2017. On the other hand, it has so far recorded a lowest value of 940.04 on 16th December of 2011.
Usefulness of GSE composite index to investors
The GSE composite index, just like other stock indices, can be used to track the overall performance of the stock market. As it was mentioned earlier, it may be difficult to monitor the performance of all individual stocks on the market. To make it easier, the GSE composite index is used to provide an overview of the performance for the entire listed stocks, which can further guide investors in their decision making.
Using GSE composite index to replicate market performance
By utilising the GSE composite index, investors can attempt to replicate or imitate it in their investment portfolios so as to match market performance. ‘Attempt’ is used here because it is nearly impossible to replicate a stock index in one’s portfolio. To be able to imitate an index, it must be practical to purchase all its constituents in the exact proportions. In the instance of the GSE composite index, it must be practical to buy all listed companies in the exact weightings they contribute to the index. This must also be achieved without suffering from extra transaction costs or having some effects on the market. Unfortunately, such conditions are ideal to the extent that they may not be feasible to attain. Practically, not all stocks would be available for purchase in such a proportion to reflect the GSE composite index. If you have been buying shares from the GSE, you may have realised that availability of certain stocks are difficult to come by. I have actually experienced this on a number of occasions, even more recently. In fact, out of an order I placed with my investment broker in August this year, some shares are yet to be available for purchase.
Even though it is difficult to replicate the GSE composite index in an exact manner, knowing which companies contribute much to the index would serve as guidance to purchase the right mix of stocks. If you would recall, it was mentioned earlier that companies with high market capitalisation influence the index more than companies with less market capitalisation. To some extent, some stocks are more important than others in terms of their contribution to the GSE composite index. To determine the extent of impact a company can have on the GSE composite index, you divide the market capitalisation of the company by the overall market capitalisation of GSE. We call this market weight or index weight. The bigger the market weight of a stock, the more influence a change in its price can have on the GSE composite index.
For example, at the end of trading on 27th October 2017, the overall market capitalisation of the Ghana Stock Exchange was GH¢ 58,497.34 million. On the same day, the market capitalisations of Ecobank Transnational Incorporated (ETI) and Access Bank Ghana (ACCESS) were GH¢ 4,332.2 million and GH¢ 461.74 million respectively. By these figures, the market weight of ETI can be calculated as (4,332.2/58,497.34) × 100 = 7.41 %. Likewise, the market weight of ACCESS would be 0.79 %.
As depicted in the examples above, a change in the price of ETI would have a much greater impact on GSE returns than an equal price change in ACCESS bank. In fact, if the price of ETI were to rise by 20% while prices of all other stocks kept unchanged, the GSE composite index would increase by 1.48% (That is 7.41 % × 20%). On the other hand a 20% price change in ACCESS bank would increase the GSE composite index by just 0.16% (That is 0.79 % × 20%).
Obviously, for an investor to attempt to replicate the GSE composite index and for that matter the GSE returns, the composition of his stock portfolio must be more of ETI and other similar stocks with high market weights. To give you a clue, other listed companies with similar high market weights (besides ETI) are Standard Chartered Bank (SCB), Ecobank Ghana Ltd. (EGH), Fan Milk Limited (FML), GCB bank (GCB) and Ghana Oil Company Limited (GOIL). If you have read my post on foundational stocks, you would realise that all the major fund managers maintain and hold greater portions of their portfolios in the above companies (SCB, EGH, FML, GCB and GOIL).
Attempting to replicate the GSE composite index or returns is particularly useful for passive investors who prefer to buy and hold as opposed to active trading. It is equally beneficial to investors (especially beginners) who find it challenging in choosing which individual stocks to invest in. This practise of investing (known as indexing) offers investors the chance to perform well as the stock market. In a way, the investor increases his chances of making gains when the market records positive returns. Don’t forget that the investor can similarly lose when the stock exchange posts some losses. However, for the many investors who are not that professional, the possibility of making gains by trying to imitate the stock index can be higher than striving to beat the market.
Using GSE composite index as a benchmark
The GSE composite index can also be used as a benchmark to evaluate the performance of mutual funds in the country. It is important to know if your fund manager is performing better or at least is simulating the returns of the GSE. Most mutual funds in Ghana, which are usually actively managed, are claimed to offer returns higher than that of the GSE. That is, instead of attempting to replicate the GSE composite index, the fund managers tend to beat the market in terms of returns. Don’t forget that these fund managers charge various forms of fees and commissions too. Thus, comparing or benchmarking the performance of their actively managed funds against the GSE composite index would be necessary to determine whether it is worth to invest in the funds or not.
Using GSE composite index as a forecasting tool
The GSE composite index may further be used to study and forecast performance trends of the stock market. Just have a look at the ‘beauty’ of the figure below? This is a snapshot of performance of the GSE since inception.
I know how difficult it may be to follow the pattern of the yearly returns. Nonetheless, one thing clear from the historical data is that apart from 1990 to 1992 (first three years of GSE operation), the stock exchange has never recorded a loss in three successive years. Moreover, since 1992, the stock market has never repeated a negative return except in 2015/2016. By using such observation, although not so significant, one may be able to predict a future direction of the GSE. This observation was similarly highlighted as part of three other factors when I wrote on the anticipation of hope for the equity market in 2017.