Imitate GSE performance returns using market weights

Investing on the Ghana Stock Exchange can be one way to secure financial independence in the long term. Notwithstanding, purchasing shares anyhow from the stock market may not yield you the desired good returns. This is likely to happen if you completely ignore the GSE composite index and your attempt to beat the market goes wrong.

Just recently, I wrote on the usefulness of GSE composite index to investors on the stock market. In the same post, I discussed about market weight and the significant role it plays when one attempts to copy or imitate GSE performance returns.

Market weight of a stock

Market weight (also referred to as Index weight) of a stock measures the degree of influence that a listed company can have on the overall performance of a stock market.

It is calculated by dividing the market capitalisation of a stock by the total stock market capitalisation. To know the market capitalisation of any stock, you multiply its share price by the total number of its listed shares. As share prices keep changing, the market capitalisations of stocks change accordingly.

Thus, the market weight of a stock may change from time to time in accordance with changing factors such as share prices and the number of listed stocks.

Impact of market weights on GSE performance returns

Since market weight depends much on a stock’s capitalisation, listed companies having higher market capitalisations would therefore have higher market weights.

Furthermore, the greater the market weight of a stock, the more impact a change in its share price can have on the GSE composite index, and for that matter the overall GSE returns.

For instance, the prevailing market weights of GCB bank and Ayrton Drugs Manufacturing are 3.07% and 0.04% respectively. In effect, a price change in GCB shares would definitely have a greater impact on GSE performance returns than an equally price change in Ayrton Drugs Manufacturing shares.

imitate GSE performance _ market weights _GCB vs AYRTON

In fact, majority of the listed companies barely have any significant impact on the GSE performance returns. African Champion Industries Limited, Camelot Ghana Limited and Sam Woode Limited are examples of listed companies whose market weights are approximately 0%

 

It is therefore not surprising that most mutual funds in the country invest in just a few of listed stocks, leaving the others out. If you take a closer look at the annual reports of the various mutual funds, you can see that the fund managers invest not even in half of the number of companies listed on the exchange.

For example, SAS Fortune fund invested in only 14 out of the about 35 companies listed on the Ghana Stock Exchange in 2015. HFC Equity Trust had similarly invested in 16 out of the 39 listed companies on the GSE in 2016. The fund managers may be doing so to concentrate more on potential performing stocks as well as stocks with high market weights.

 

See also: Investment diversification: Smart means to diversify your assets

 

Using market weights to match GSE returns

The average GSE performance return may be argued as not so impressive. Nevertheless, it outweighs earnings of other investment products, in particular savings accounts. Unfortunately, not every investor on the stock exchange is able to match the returns posted by the GSE.

You may be hearing series of positive updates about the stock market performance. Updates such as “GSE records 16.31% return in first half of the [2017] year”, “GSE begins second half of the [2017] year with impressive performance”, “GSE return for 2017 caps at 52%”, “GSE begins 2018 on a good note” and many more.

Yet, you keep wondering why these returns never reflect on your stock portfolio. Even though you have invested much on the Ghana Stock Exchange, the earnings on your stock portfolio appear to be far from the reported GSE returns.

 

One way to bridge the gap between the returns on your stocks and that of the GSE is to consider market weights of stocks during purchasing. As earlier mentioned, a lot of stocks listed on the Ghana Stock Exchange virtually have no impact on GSE performance returns due to their low market weights.

Frankly, there are some stocks that can even be tagged as ‘non-score’, due to their insignificant contribution to the GSE performance. Hence, if your portfolio is dominated by such stocks, the possibility of performing closer to the GSE return would be much less.

 

Since market weights and for that matter GSE composite index change with trading activities, it may be impossible to imitate the exact GSE returns. Nonetheless, by considering stocks with high market weights, the performance of your stock portfolio can, at least, get much closer to that of the GSE.

Your focus is to favour stocks with high market weights while taking critical look at their historical performance trends at the same time. Considering performance trends is necessary to avoid the tendency of locking up huge investments in poor-performing stocks.

In the link below, you would find the market weights of all listed companies on the Ghana Stock Exchange:

Market weights of listed companies on GSE