Understanding factors that influence choice of stocks

Despite the potential risks and returns, the bottom line is that people put their money where they feel comfortable. PHOTO | FILE 

By SCOTT BELLOWS

In Summary

• Next time you desire to stare at financial statements from a firm listed on the Nairobi Securities Exchange, perhaps also hold a focus group of small investor emotional responses to possible news items and you may earn surprising stock market returns once eventual news comes out and you react quickly.

Musa Mutetwi always loved computers from an early age. When he turned 10 years old he received his first computer. Musa always felt like his life really began from that point forward. When he entered university, he formed a company called Musa Soft LabX.

The firm revolved around information systems and applications development. Over the years he gained the trust of universities in Kenya and developed their student election voting systems.

Now successful with a strong company and popular products, Musa realised that keeping the bulk of his earned funds in a current account did not make much investment sense.

Like many young entrepreneurs who finally gain traction in their companies, he pondered different choices and desired to invest his earnings into diversified assets.

However, coming from an information technology background, Musa did not feel knowledgeable enough on investments to make proper asset choices. So he turned to some investment managers.

Unfortunately, the investment managers poured so much information back to Musa, that he felt overwhelmed. So with the help of some finance majors at his university, he decided to go forth and purchase stocks listed on the Nairobi Securities Exchange.

Continuing our behavioural finance series in Business Talk, Martin Sewell of Cambridge University defines behavioural finance as economics and finance combined with behavioural and cognitive psychological theory that provides explanations for why people make financial decisions.

What drives our decision to invest in a particular asset?

Why do we as Kenyans strongly prefer to buy land as our preferred asset store of value instead of gold like in Russia, pensions as in Europe, stocks akin to Americans, or cattle as our brothers and sisters up in South Sudan?

We buy assets that we feel safe to store our hard earned investments and hope that enough demand for that asset in the future may cause significant appreciation.

More and more Kenyans continue to choose owning shares of common equity in large firms. The Nairobi Securities Exchange now holds over Sh2 trillion in market capitalisation.

Now, in narrowing down our preference to equity trading, what makes us select a company trading on the Nairobi Securities Exchange? If we see a nice television commercial for Uchumi, Safaricom, Diamond Trust, do we then feel biased to buy the stock?

Furthermore, why do we choose the Nairobi Securities Exchange over investing pan-African in the Johannesburg Stock Exchange?

Even right-wing alarmists in the Western world also invest in gold and silver largely over a misunderstanding of the supply and demand aspects of the modern economy.

In sub-Saharan Africa, citizens in countries without a history of solid land rights protections or financial infrastructure prefer tangible assets such as cattle.

As citizens feel comfortable with such investments, they demand more and, inasmuch, push up the price of the asset. No asset really holds intrinsic value despite right wing assertions.

Gold, silver, cattle, tomatoes, dollars, or even shoes hold no value at all unless people desire and therefore demand them. So investors should make decisions based off of their predicted assumptions about future consumption patterns.

Americans rudely woke up to the above fact that even though they may have purchased a luxury vacation home in Las Vegas in 2005 for the equivalent of Sh100 million, by 2008 if no consumer demanded real estate in Las Vegas, then the same home could have possibly only sold for Sh30 million (Kenyan money).

So how do wealthy successful stock traders earn money from the securities exchanges? They make long-term predictions about the citizenry’s emotional demand for products and services.

Kenyans may never hold equities in the same proportions as Americans, so perhaps more visible firms do better over time here.

High-frequency traders really do not care if information that gets released on traded firms is accurate or inaccurate.

As former US Attorney General Schneiderman once proclaimed “high frequency traders just want to know what (information) is coming out on the market that might sway public sentiment”.

So a nation that enjoys tea and may develop a new kind of tea, then its citizens may excitedly buy stocks in tea firms.

Also, a country with a bank that releases news about an employee restructuring that may actually hurt the firm, citizens may incorrectly view the restructure positively.

So investors may senselessly buy the stock and thus their increased demand may push up the stock price. Large investors would then jump on the investment early by purchasing much of the stock once an informational announcement comes out, and sell as the rest of the population behaviourly reacts.

Research by Theirry Foucault, Johan Hombert, and Ioanid Rosu released last month showed the power that high frequency large investors hold over the market.

Such individuals make money based on predicted investor behaviour, rather than stock fundamentals, and the faster they invested following market information releases, then the more returns they gained.

So the next time you desire to stare at financial statements from a firm listed on the Nairobi Securities Exchange, perhaps also hold a focus group of small investor emotional responses to possible news items and you may earn surprising stock market returns once eventual news comes out and you react quickly.

Perhaps even the 16 single listed or seven cross-listed companies (most of them Kenyan) on the Dar es Salaam Stock Exchange may draw our investment shilling.

The bottom-line, people invest where they feel comfortable. Citizens in countries that experienced turbulent banking histories often invest directly in precious metal commodities because of the tangible nature of the investment.

Share your investing stories with other Business Daily readers through #KenyaInvestment on Twitter.

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Prof Scott serves as the Director of the New Economy Venture Accelerator (NEVA) and Chair of the Faculty Senate at USIU, www.ScottProfessor.com, and may be reached on: info@scottprofessor.com or follow on Twitter: @ScottProfessor