Buying shares/stocks is among the key financial investment options in the market today. With the increase of company listing, millions of people are taking the opportunity to invest in this market.
The market where buying of shares happens is known as the stock market. Almost every Kenyan has a chance to invest in this market as long as you have a trading account. This article will focus explain factors to consider when buying stocks in Kenya.
Most of the time new investors get difficulties in choosing the stocks to invest in. This is because there are many options in the market operating in different industries. Settling on the right stock requires extensive market research and consultation.
Remember that when you buy stock, you are betting on a future good performance to enable make returns either in stock price gain or dividends. There is also a level of risk you carry if the company doesn’t perform as expected. This makes
Blind investing is detrimental since it can lead to losses. This is a common mistake most starters make; investing without performing proper analysis. Whenever you invest in a company’s shares, you become a shareholder of the said company. As a shareholder, you own part of the company that is equivalent to your shares’ worth. This means that you share in the profits and losses of the company.
So, how do you identify the best company to invest in?
Here are the main factors you should consider before buying any shares.
1. Investment objective
Every investor has different objectives that they would like to achieve from their investment portfolio. The different objectives vary according to the risk tolerance and financial need of the individual. All the different objectives call for a different investment strategy.
There are three main types of investors according to their investment objectives.
· Value investors
Some investors focus on growing their investment value over time. They target undervalued stocks in the market with the aim they would get a price correction over time. Value investors also target the long term. This is because it takes time for the share price to grow. they are ready to hold a stock for more than 10 years.
These investors compare the intrinsic value of a company to its current market value. When the intrinsic value is at par or exceeds the market value, it is considered a worthy company.
The intrinsic value of a company is the investors’ opinion of what a company is worth. Every investor has a formula for calculating the perceived value of a company.
The common belief is that, if the intrinsic value is higher than the market value, chances are, the share price will increase with time.
Although value investments grow at a slow rate, their value still increases in the long run. If you invest in this type of stock, your money will grow over time. it is a favorable policy if you are looking for a place to invest your pension fund.
· Dividend investors
Dividend investment involves investing in shares that pay out frequent dividends every year. Dividend shares provide you with a steady income stream since you can predict the frequency of payout.
Dividends are the regular earnings you get from investing in shares and stocks. These are mostly paid half-yearly or yearly.
The main companies that pay out dividends are blue-chip companies. Blue-chip companies have consistent profits and are considered stable and mature since their earnings have less frustration. Blue-chip companies are usually the top companies in their given industry.
Due to the nature of blue-chip companies, they are in a position to make regular dividend payments. By investing in dividend stocks, you can choose to receive the dividends or to reinvest them back in the stock market for increased earnings.
· Growth investors
Growth investing involves investing in stocks that have beaten the average market performance for some time. The belief is that the growth stocks will continue beating the market performance even in the future.
Since growth stocks grow at a faster rate than the market index, they offer better prospects than value stocks at times. Investing in growth stocks is favorable if you are looking to grow your capital.
2. Time horizon in the market
Another factor to consider is the time you plan to hold on to your shares. There are three types of investors according to the time horizon in the stock market
- Short term investors
You are a short-term investor if you plan to invest for less than one year in the stock market. The best types of stocks for this strategy are blue-chip stocks.
Blue-chip stocks are the stocks of blue-chip companies. Since blue-chip companies regularly pay dividends, sometimes quarterly, you will receive better yields from your investments.
Blue-chip stocks are relatively stable offer high income within a short period.
- Medium-term investors
These investors target to stay in the market between 1 to 10 years.
Medium-term investing offers a longer time in the market compared to short-term investing. It, therefore, gives you a chance to invest in some slightly riskier stocks than you would have in a short-term investment strategy.
With a medium-term investment, you can invest in stocks that are moderately risky since you have time to ride through the price volatility.
- Long term investors
Long-term investing involves holding shares for more than 10 years. With this time of investment, you can afford the luxury of investing in risky investments.
The long period of the investment allows you to ride through major market crashes and recover the money when the stock market recovers. This kind of stock investment requires patience. It is also suitable for the younger investors who have adequate time to wait.
3. Volatility/Beta value
Volatility defines how easily a stock reacts to market changes. Beta is the measure of the volatility of a company’s stock. This makes an important to consider when buying stocks in Kenya
Volatility can be both positive and negative depending on the price movements. If volatility is in your favor, it is positive. However, if it moves against you, that’s negative volatility.
Aggressive and experienced investors with a high-risk tolerance love volatile stocks since they have good risk management skills. However, when starting, it is advisable to stick to stocks with a beta measure between 0 and 1.
If a stock has a beta measure of 1, it is considered to be very volatile. Therefore, consider your risk tolerance and decide whether you can withstand investing in volatile stocks or you would rather choose less risky stocks.
4. Market capitalization
Companies are divided into different groups depending on their market capitalization. The market capitalization of a company is also known as ‘market cap’.
It is the value of a company that is determined by multiplying its authorized shares by their market value. When the debt-equity of a company is also included, it is known as the ‘enterprise value’
The market capitalization of a company determines its valuation since companies with a high market capitalization are generally worth more.
The main categories of companies in terms of market cap are:
- Penny stock cap
These are companies with a total market cap of below $2 billion. They are relatively small and comprise mostly of newly listed on the stock exchange market. Their shares tend to be riskier and have low profitability.
Due to their small size, they are easily affected by the industry market fluctuations. High-risk investments such as penny stocks require experience and good risk management to invest in.
As a beginner, you should stay away from these stocks unless you are sure about the chances of their future price growth.
- Mid-cap stocks
These are companies with a total market capitalization between $2 and $10 billion. They are less risky than penny stocks since they are in their growth stage.
However, they are still riskier than blue-chip stocks. If you find a potentially undervalued company in this category, there is a high chance of making attractive returns.
- Large-cap stocks
These are companies with a total market capitalization above $10 billion. They are mainly made up of top-tier companies in various industries. Shares from these companies are considered less risky than all other companies.
Their large market capitalization portrays investors’ confidence in them. These companies regularly pay dividends to their shareholders and also engage in share buybacks.
5. Price to earnings ratio
The price-to-earnings ratio is calculated by dividing the company’s share price by its annual return. For example, consider company A whose stock was valued at 50 shillings at the beginning of the year. If the total annual dividend paid for the share was 10 shillings, then the P/E ratio is (50 ÷ 10) which gives 5.
The above P/E ratio shows that for every 5 that you invest, you will earn 1. Companies with a high P/E ratio are considered expensive. However, if you find an undervalued company with a low P/E ratio, you can consider putting that company on your watch list.
To understand a company’s P/E ratio, compare it to other companies in the same industry. This is one of the best ways to identify whether the company has a high or low P/E ratio.
6. Technical and fundamental analysis
As a new investor, you should do adequate analysis and research to identify the viability of a stock before investing.
There are various scientific ways to do this. They are known as both fundamental and technical analyses. This analysis helps mitigate stock investing through emotions and greed.
Only invest in a company based on facts. This can be established through the financial statements and relevant ratios.
To get a clear understanding of a company’s financials, analyze them and compare the performance to the general industry performance and that of close competitors. This analysis is key when buying shares/stocks.
Some of the financial information and performance ratios to consider are:
· Balance sheet
A balance sheet gives a snapshot of a company’s financial position at a specific date. Public limited companies are required to file their balance sheet publicly and regularly. This makes it easy for shareholders and potential investors to analyze the performance at will.
A balance sheet lists all the assets and liabilities that the business has. With this, you can compare the different liabilities of a company relative to its assets.
Compare the balance sheets of different companies in the same industry to get a better comparison of a company’s financial position.
· Debt to equity ratio
The debt to equity ratio measures a company’s debt to its total equity. This ratio gives the percentage of the company’s equity that is financed through debt.
It is common for companies to use debt in meeting their needs. However, some companies are overly on debt exposing them to huge financial costs in the long run.
Whenever a company takes up debt capital, they have to pay it back with an interest. If the debt capital is too much and there are unfavorable prevailing market conditions, the company will strain to pay off the debts.
This increase in the debt costs poses a risk if it is unable to meet its obligations. It also results in a reduction in profits affecting the payment of dividends as well.
Hence, companies with a debt-to-equity ratio above 2 are considered a risky investment. Low-risk companies in terms of debt have a debt-to-equity ratio below 1.
7. Share buy back policy
A share buyback happens when a company buys back its shares. So, how does a share buyback affect your investment?
Consider 2 companies each with a market cap of 100,000,000 shillings. If Company A has 1,000,000 authorized shares, each share is valued at 100 shillings. If company B has 500,000 authorized shares, each share is valued at 200 shillings.
Even though both companies have the same market cap, their shares have different values. Shares in Company B are worth more since they are less in number.
Therefore, when a company buys back its shares, it reduces the issued number of shares. The effect of this is an increase in the value of existing shares.
If you invest in a company that has a share buyback policy, you have a chance of increasing the value of your investment. This makes it an important factor to consider when buying shares/stocks.
8. The type of shares
There are 2 main types of shares. These are both preference shares and ordinary shares.
They are the most common type of shares. Shareholders of this stock type have voting rights and also share in any residual profit once all other stakeholders have been paid.
Although they are attractive, they also have their disadvantages. In the case of a company dilution, ordinary shareholders are paid last. In addition, dividend payments are not a guarantee.
These shareholders do not have any voting rights in the company. However, the upside is that dividend payments are almost always guaranteed. Preference shareholders take precedence over ordinary shareholders in times of dividend payments and company dissolution.
It is critical to understand the types of shares before investing to enable understanding the privileges and responsibilities that come with them.
9. Dividend History
Another important factor to consider when buying stocks in Kenya is the dividend history of a company. The dividend history of a company focuses on the dividend amount per share and the frequency of payment over a specified period.
Although value and growth do not care much about regular dividend payments, it is still an indication of the company’s performance. Ideally, you should look for a company with an increasing annual dividend yield.
Increasing annual dividend yields indicate positive company growth and financial stability in the company. To avoid investing in a company that uses debt capital to finance dividend payments, analyze 3-5 years’ worth of the company’s dividend history.
10. Investment diversification
Investment diversification involves spreading your investments across different industries. It is a recommended strategy for new investors.
For example, if all of your investments are in the technology industry, a tech industry crash can cost you your entire portfolio. A way to hedge against this risk is by investing in another industry that is not directly related to the tech industry.
Nowadays, it is easy to find diversified investment plans in various stock markets. For example, the NYSE has the S&P 500, which tracks the performance of all the top 500 companies in the US economy. Investing in this fund is similar to investing in the top 500 blue-chip stocks at once.
Conclusion on factors to consider when buying stocks in Kenya
Investing is one of the ways of achieving financial freedom. Since investments provide capital appreciation in the long run, it is viable to invest in various assets.
However, as a starter, it might be confusing to decide on which stocks to invest in. There are many companies listed in the stock market but not all of them match your investment needs.
Some of the factors to consider before buying shares are:
- Investment objective
- Time horizon in the market
- Volatility/beta value
- Market capitalization
- Price to earnings ration
- Technical and fundamental analysis
- Share buyback policy
- Type of shares
- Dividend history
- Investment diversification