Wednesday, 26 January, 2022

Fundamentals of Investing in the Capital Market

Md. Latiful Islam and Moinul Hossain Asif

Whenever we discuss investment in the Capital Market, the first question may come - why people will invest in stocks. Investment plan is a vital for the surplus spending unit i.e. people who have surplus money after their regular expenses. However, deficit spending unit and marginal unit also invest in different forms. We shall focus here how capital market can be a good choice for investment.

In our country, scopes of investing surplus funds are mainly limited to depositing in Banks/FIs, purchasing National Savings Certificates, investing in real estates, trading business, investing in capital/stock market etc. Price of real estate is to some extent constant or in a declining trend over the last few years and there are some complications in this business. Investment in real estate is not easily liquid able at the time of emergency of fund. For trading business, it requires investing much more time and there are some challenges. So, most of the people are not in favour of investing in real estate and trading business. In that case, purchasing of national savings certificates, being the government issued bond, is risk free and rate of return is better than depositing in Banks/FIs. But, to get a good return from these certificates, investors have to block the fund for 3 years to 5 years based on the type of the bonds. On an average people may earn around 9% pa interest where 10% withholding tax is deductible on the interest earned.

Recently government has reduced the rate of interest and imposed some conditions in purchasing saving certificates/shanchya pattra. The major portion of funds is being deposited to different Banks in the forms of current, savings and term deposits. People also invest in non-banking financial institutions (FI) in the form of term deposit. As per Bangladesh Bank instruction, maximum interest rate on deposit is 6% pa. In the savings deposit account, rate is 2% - 3% pa and even lower than 2% offered by some top rated banks. Due to liquidity crisis experienced by few banks and FIs in the past years, investors are sometime choosy in selecting banks/FIs where they may invest their hard earned money. In that case, top rated banks/FIs offered comparatively lower rate of interest. Here, withholding tax (10% for eTIN holder and 15% for others) is deductible on interest earned on deposits and also Excise Duty is deductible once in a year based on balance slab.

So, after all deductions in the accounts, highest amount of interest earning (as per rate guided by Bangladesh Bank) from banks/FIs deposit account is less than 5.4% pa. The interesting part is that investors do not consider inflation rate of money. i.e. what you can buy with Tk.100.00 now, price of that will be higher than Tk.100.00 after one year. That’s why inflation of money comes in front while calculating net return on investment. In Bangladesh, inflation rate in the year 2021 compared to 2020 is 5.57%. So, if you consider inflation rate, net maximum return on investment in Banks/FIs is negative whereas net return on investment in national savings certificates is little bit positive. However, as there are no other risk-free and liquid able forms of investment alternative, people secure their investment in the Banks/FIs and in the government bonds to protect their surplus funds for future.

Now let us come to the answer of the question placed before. The primary reason that most people invest in the capital market is to maximise potential return compared to any other alternatives we discussed here. Returns in the stock market often significantly outpace the rate of inflation. If the investor chooses a good track record company, dividend income can help to supplement an investor as good source of second line of income or retirement income. A share of stock represents fractional ownership of a company. So, the investor can own a small portion of a company that gives the investor feelings of being an entrepreneur. Stocks are traded in the stock exchange easily to buy and sell them. So, investment in stock is also liquid able. Investors get tax rebate for investment in the stocks and also capital gain on stock is tax free. These are extra incentives for investing in the capital market compared to other choices. Although capital market is risky sometimes but the investors can minimise the risk through wisely managing their portfolio which ensures high rate of potential return. People should target on dividend yield and trend of capital gain of the company based on the performance of last consecutive years. Share market is seriously volatile and there are big ups and downs in the price of the stocks during different point of time in a year. So, who plans to invest for the short term of period, share market is not a good choice for them.

The next question that comes in investing in stocks is “What are the things that should be considered before investing in a company?” To protect investment in the stocks, investor must make fundamental analysis of the company to determine whether the company’s stock is correctly valued within the broader market. There are some qualitative and quantitative parameters to do fundamental analysis. For qualitative analysis, the following parameters are considered:

♦               Business model: basically to see products or services of the company, target customers and market demand of the products or services.

♦              Competitive advantage: A company's long-term success and acceptability of the brand by the customers compared among the similar type of companies.

♦               Management: In our market, management (board and top executives) is the most important criterion for investing in a company.

♦               Corporate Governance: Corporate governance includes the policies in place within the company denoting the relationships and responsibilities between management, directors, and stakeholders.  The company must do business legally, ethically, fairly, transparently, and efficiently. It is important that their communications to shareholders are transparent, clear, and understandable.

Quantitative analysis describes financial position of the company based on balance sheets and profit & loss accounts. The top line of the company is to maximise sales and the bottom line is profit. The major parameters in quantitative analysis are cash-flow, earning per share (EPS), price-earning ration (P/E), net assets value (NAV), retained earnings, cumulative loss if any, dividend records & dividend yields for last 4/5 years, total capital, long term & short term liabilities of the company etc. People sometimes see number of free float shares, institutional & foreign investments, directors’ holdings to anticipate price volatility of the stock.

Ideally, profit comes in the capital market from dividend and long term capital gain. If price of stock goes up in between to take expected profit, investor should take that opportunity. However, most of the investors in our capital market invest to gain short term profit. They do not go for fundamental analysis and follow brokers’ instructions, rumours, posts in the social media and fake news to trade stocks. Gamblers take these opportunities and artificially make price hike of their targeted stocks. When market falls down, general investors become panic to sell their stocks at loss. This is the main reason that people do not keep trust on the capital market. If the investors do minimum analysis before trading stocks, chance of loss is very minimum.

Investing in capital market directly and indirectly help in increasing country’s GDP through establishing and developing industries. An individual having surplus money cannot manage his/her fund to earn desired profit whereas, an entrepreneur can smartly use these idle funds to maximise profit through increasing production. There may be bad companies and gamblers in the capital market. An investor can manage all these risks by applying analytical sense in selecting companies, taking buying & selling decisions, keep patience during the dull market and mentality to hold the stock for long term of period. Investors of capital must have patience, analytical sense and control over greed. If all the investors follow the fundamentals, the capital market shall be the best stable platform of investment.


The writers are Chairman and Managing Director of FinPro Consultants Limited