By Tumbul Trawally, Seattle, USA, 7th October 2023,
First, Congratulations to President Barrow, Secretary of Finance & Economics, Seedy Keita, and the Governor of the Central Bank, Buwa Saidy, for establishing a Capitals Market in The Gambia. I wish it had been established years earlier, but hey, “it is better late than never”. Give credit where credit is due! Now that the Capitals Market is open, the next critical step is to privatise all the State-Owned Enterprises (SOEs), and have them listed on the Exchange. First, let the government hire independent Accounting firms to calculate the true Book Value of the SOEs. The Book Value of the SOE will determine the number and price of shares to be issued. The Gambia government should own nothing more than a maximum of 49% of the shares, which leaves a minimum of 51% of the shares to be owned by private enterprises and the public. The money received from the sale of the 51% of shares to private enterprises and the public should be reinvested into the SOEs, to enable then purchase new equipment and to improve customer services. Because the private enterprises and the public own a majority of the shares, they should appoint the Board of Directors, who in turn, appoint the management of the SOEs. Government should have a seat on the Board of Directors, as a major shareholder. The Board of Directors should appoint the management team of the SOEs. However, if the government insists on selecting the management team, as the single largest shareholder of the SOE, then the Board of Directors (most of whom should be appointed by the private sector and individual investors) should have the power to terminate the services of a non-performing management team. The buying and selling of shares will be coordinated and regulated by the Capitals Market, which will ensure the liquidity and the smooth selling and buying of shares.
Ownership of shares of the SOEs will enable Gambians to benefit from the dividends paid out by the SOEs and the appreciation of their share price. This enables our citizens to share in the prosperity of the SOEs and other private entities listed on the Capitals Market. It is a way of increasing the middle class. Lack of a vibrant middle class is one of the impediments to the growth of African economies. The middle class has a lot of unmet needs; therefore, they always purchase durable goods, which is the engine of an economy. Instead, we have a few people at the top of the social pyramid, nothing in the middle (middle class) and the rest at the bottom, fending for daily survival. When a citizen owns shares in an SOE or private company listed on the Exchange, he/she will not turn a blind eye to irregularities in the enterprise. The reason is that he/she has [skin in the game] or vested interest in the viability/profitability of the entity. There is nothing altruistic about the private citizen’s behaviour—it is all about looking out for his/her investment.
Long term investment is not for the faint of heart. In the Seattle area, Microsoft Corporation created a lot of millionaires. When Microsoft went public on March 13th, 1986, its initial share price was $16. Anyone who bought 1,000 shares for $16,000 and did not redeem or sell their shares by 2003, became millionaires. Microsoft did not pay dividends in its early days, the gain solely came from the appreciation of the stock price. This is how you let the prosperity of enterprises to be shared by the general public and private enterprises.
As the Capitals Market matures, a Futures Market can be opened to trade in cattle, sheep, nuts, and grains. Farmers will have a fair market price for their goods, which will be based on supply and demand, not on an arbitrary price set by government bureaucrats. The Futures Market will ensure payments to the sellers, just like a Capitals Market. Having a fair market price for their produce will encourage farmers to increase their acreage, and will induce other citizens to engage in farming, horticulture, or animal husbandry.
For the younger generation, who have a long-time horizon, and money lying around, which is not next month’s rent or for purchasing groceries, the investing principles of Warren Buffet, the multi billionaire American investment guru, the “Free Cash Flow” (FCF) can be life changing. Warren Buffet learned this investment method from his professor at Columbia University, Benjamin Graham. The fundamental principle of the Free Cash Flow method is to focus on the cash generated from the operations of an enterprise in determining its value, and disregarding the non-cash items on the balance sheet. In other words, when you look at a Balance Sheet, look for the number that represents the Total Assets. Subtract from it the non-cash items, like Depreciation, Amortisation, or Goodwill. The result is the Earnings before Interest, Taxes, Depreciation, Amortisation, and Goodwill (EBITDA).
Let us look at a very simple Cash Flow from Operations Statement:
Before-Tax Cash Flow from Operations: ———- $
Total of Taxable Income: — $900,000
Taxes (at 30%): ——— 270,
Goodwill/Amortization: —– $100,000
Total Free Cash Flow from Operations: ————— $530,0000
After subtracting the Depreciation, Taxes, Goodwill/Amortisation, we arrive at the EBITDA. In this example, the Free Cash Flow from Operations is $530,000. Obviously, this is a very simplified Cash Flow Statement of a company.
The next step is to determine the Return on Equity (ROE) of an average company, which I assume to be 10%. It is a reasonable Return on Equity (ROE) expected by owners of the shares. The ROE or investment in a company or a specific industry can be obtained from the Central Bank, the ministry of finance and economics, or the Bureau of Statistics. The interest rate of the 10 year notes, which I assume to be 4%, is my discount rate. The interest rate of the 10-year Note is not a secret; it is published by the Central Bank. The question becomes, why use the 10 year note interest rate to evaluate the company? The answer is, the interest rate of the 10 year note is the benchmark for all interest rates in an economy, because it is deemed to be “risk free”.
If you want to know the value of this hypothetical company, here is the formula:
V: Value of Firm
C: Free Cash Flow from Operations
R: Return on Equity
T: Interest rate of the 10-year Note
V = C/(R-T) plug in the numbers:
V = $530,000/ (10%-4%)
To showcase the brilliance of Professor Benjamin Graham, he adds 1% to the interest rate of the 10-year notes in discounting the Free Cash Flow from Operations, to give him a [Margin of Safety]. Therefore, the final formula will be:
V = $530,000/ (10%-5%) which becomes
V = $530,000/ (.1-.05)
V = $530,000/.05 = $10, 600, 000
Therefore, the intrinsic value of this imaginary firm is ten million and six hundred thousand dollars ($10,600,000). That is a far cry from the Accounting Book Value of the firm. The answer is—while accounting focuses on the historical data in valuing a firm, economics and finance focus on the potential of a firm’s ability to generate future cash flows from its operations.
If the company issues 10,600 shares, then the intrinsic or real value or price of a share should be $1,000 (10,600,000/10,600). If the share price of this stock is $900 on the Capitals Market, you should buy it—if it is $1,100, you should not buy it. This is one of the investment methods used by Warren Buffet, which was formulated by his Professor at Columbia University, Benjamin Graham. It is also his most favourite! There will be gyrations or swings of the share price, just like the swings of a pendulum. When that happens, do not panic! Just like a pendulum, it will swing back to equilibrium, and in the case of a stock price, that is the intrinsic or real value of the stock or share, unless something catastrophic or unforeseen misfortune hits the firm. As long as the company or SOE is generating cash from its operations, the stock price will rise, no matter how long it takes. In a similar vein, some economists have been predicting a recession for more than a year in the United States. Again–as long as the economy continues to create jobs and consumers continue to spend money, there will be no recession.
No one should base his/her investment portfolio on this principle, if you are not going to be an active investor, or keep up with all the relevant news related to the firm. Warren Buffet has dozens of investment analysts, who look for the intrinsic value or real price of stocks daily. When they spot an advantageous misalignment of the intrinsic value and the share price, they buy the share; if it is the opposite, they sell the share, pretty similar to what I mentioned in the above paragraph.
As an active investor, always look for more information in the Footnotes of a Balance Sheet, Cash Flow Statement, Income Statement, or Equity Statement. This is where vital information about the line items on the statements can be found. Like when a firm collects a one-time insurance settlement or sells or buys a building, the line item on the statements will not reflect that information. It is the footnotes where that information is found. Therefore, a one-time inflow or outflow of cash (or as accountants call a Contingency) should be subtracted from your Total Free Cash Flow from Operations.
Opening a Capitals Market comes with a lot of responsibilities, one of which is the auditing of the books by independent Auditors. The Auditors should not be beholden to the SOEs or private enterprises listed on the Capitals Market. The Auditors should follow the International Generally Accepted Accounting Principles (IGAAP). There should be no shady accounting gimmicks, as we saw in the cozy relationship between some companies and their Auditors, where [Unearned Revenue], which is cash received by a company, but the service has not yet been rendered, or merchandise not yet received by the buyer, entered as assets, instead of being entered as liabilities. This practice of accounting distorts the assets, liabilities, cash flow, and equity of a company. In a similar vein, banks should record customers’ deposits as “Unearned Revenue” under Liabilities, not as assets.
As I mentioned in my previous article–as Gambians—and Africans—in general, we can learn a lot from the cordial and symbiotic relationship between the Indian, Chinese, and Israeli governments and their diaspora. The higher disposable income of the diaspora can be invested in domestic companies, which will enable them to grow and create more jobs for our citizens. It also enables the diaspora to invest in the wellbeing of the country, without being on the ground. No savior will drop from the sky to develop our economies and reduce unemployment. Last but not least, all points of cash transactions should be replaced with automated transactions, to reduce fraud and theft of the SOEs’ assets. All my nieces and nephews in Jokadou Bakang, Karantaba, and Tambana have smartphones; therefore, there is no excuse for not automating cash transactions. This is my very humble and modest contribution towards our Capitals Market. Good Luck and Happy Investing!
Caveat: This investment method is not for an inactive investor or someone living on Social Security. It is for young individuals who have disposable income and will be active investors. In other words, you will keep up with the latest information about the company you are invested in. If you are a pensioner, your safest investment vehicle would be a diversified Mutual Fund, or an Exchange Traded Fund (ETF). An ETF’s value depends on the underlying commodity it is traded in. This could be gold, oil, soybeans, you name it.