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KenGen: lessons for the budding investor

Jun 04, 2006 Management, Sunday Nation

The dramatic KenGen flotation story is far from over. A quarter of a million Kenyans stepped up to partake in the buying frenzy that was the country’s biggest-ever Initial Public Offering (IPO), and became shareholders. For some it was their first venture into stock-market investment; other, more grizzled investors tapped their noses wisely as they made out their cheques. And as I write this, buyers and sellers are wrestling to close transactions that value the share at nearly 4 times its offer price.

Kenyans are developing a taste for the stock market. Small investors are seeing the prospect of quick returns or steady dividend income streams. Companies of a certain size and ambition are asking themselves: is it that easy to raise money? And should we step forward to take the leap into public ownership?

This, let it be said, is a fine thing. The more the ordinary Kenyan participates in the activity of business, the stronger and more stable we will be as a nation. KenGen certainly taught us one thing: there is great untapped potential for raising local capital for strong business ventures. The lines of investors that queued up took even the most seasoned advisors by surprise. So, as a nation, can we use this reservoir of capital to end our beggar mentality?

Equally, the success of the IPO is causing excitement in the private corporate sector. A path to growth is now visible to many business owners. Many are sitting down to plan their own plunge into the stock market, to take their place amongst Kenya’s publicly listed elite companies. The Nairobi Stock Exchange is ecstatic; corporate advisors are rubbing their hands in anticipation.

It is precisely at times like this that we should sit down for a moment and think about some fundamentals. Why does anyone buy shares, and why does anyone sell them? What’s the economic rationale, and what should we always remember?

I recommend some sober thinking precisely because the mood in the markets is anything but sober right now. Mr. and Mrs. Tea Farmer from Limuru, and Miss Advertising Executive from Nairobi, all lined up together to buy KenGen shares. Why? Some, I would like to think, studied the company’s business model, its track record and the strength of its management team. Many, I fear to conclude, were mesmerised by the oldest financial investment dream of all: double your money overnight!

Those who managed to sell in the first two days of trading will have quadrupled, not just doubled, their money. So the queues may keep building in future: of ordinary people wishing to be part of the miracle of money-for-nothing; and of private companies wishing to take their beloved entities to this seemingly very welcoming market.

Ngojeni, tafadhali. The world has not changed overnight. People still pay for value, not for hot air. Companies must still provide a solid product or service, and they must do so efficiently and effectively. There has been a certain euphoria built up around KenGen, yes: but it is fundamentally a sound business prospect with an assured market; it has also made dramatic improvements in its management and governance in recent years. There is reason to view it with a degree of confidence.

But beware: irrational behaviour dogs markets around the world. Many investors attach too much importance to recent news and the sentiments of their peers, and too little to sound long-term evaluation of their investments. Irrational patterns of behaviour are often mimicked by others, leading to large waves of capital flowing into bad places. This can cause extended price deviations away from the true underlying (‘intrinsic’) value.

But here’s the point: it doesn’t last. Bubbles do build up from time to time; but being bubbles, they always burst. Prices do deviate from the levels demanded by the fundamentals that determine them; but they eventually return to their ‘true’ range. Markets can get out of sync with reality, and they can do so for long periods. But experience shows that reality eventually kicks in again.

Studies demonstrate that long-term returns on capital have been remarkably similar in the world’s major markets over several decades. Analysts have estimated that over time US and UK stocks have been fairly priced, reflecting their intrinsic value. Large deviations are usually followed by corrections – sharp or gradual. In the long run, economic fundamentals drive share prices. Eventually, KenGen’s share price will reflect the strength of the underlying business – nothing else.

Wannabe investors would do well to heed the advice of Warren Buffet, the world’s most successful investor, whose personal fortune is worth much more than Kenya’s GDP. Mr. Buffet made his money entirely through investments – mostly in opportunities available to any other investor. If my father had invested US$ 10,000 for me in Mr. Buffet’s company, Berkshire Hathaway, in the year that I was born, that money would be worth US$ 40 million today. (He didn’t).

So how does Mr. Buffet do it? In his own words, he only invests in companies whose business model he understands. If he doesn’t get it, he doesn’t get in. He famously stayed away from the ‘dot-com’ companies that dominated stock markets five years ago, to much derision. The resulting crash vindicated him. Mr. Buffet also looks for a consistent trading history, and favourable long-term prospects (most dot-coms had neither).

Some of his advice: look at the business, not the share; buy a share as though you were buying the whole company; study the ability and integrity of the top management team; never be swayed by emotion; ignore the crowd and its fashions; always be willing to hold a good share for 10 years or more. This advice will not bring you the quick ‘kill’; but over an extended period it may well earn you outstanding returns.

Mr. Buffet says the search for returns is nothing other than the search for outstanding businesses: “Our goal is to find an outstanding business at a sensible price, not a mediocre business at a bargain price.” And that is the lesson for us in our fledgling stock market. Let us, investors and business leaders alike, build and support outstanding businesses. That means businesses with a clear and compelling strategy, with outstanding governance and superb brands, run by immensely talented people who build world-class organisations. If we are true to this, we will deepen and widen our stock market in the right way, and we will reap the reward.

If we take our eyes away from these fundamentals for too long, we may well see our dreams go ‘pop’. We are not in bubble territory yet in Kenya: economic fundamentals remain strong across a range of sectors, reflected in growing profitability. KenGen may have done the needful: of bringing a whole new class of investor into play. But sustained success will not come amidst the noise of the galloping herd; it will emerge from quiet examination of what makes businesses truly great.

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