The Good And Bad Of "Kobo" Stocks

Someone once told me he was buying a particular stock in droves because he thought the shares was so cheap the share price couldn’t go anywhere else but up. The stock was trading for 50kobo per share which coincidentally was the lowest share price for a stock at least on the Nigerian Stock Exchange. It was also a bank stock and the bank was still in operation. On a closer look I realised why the stock was trading at such a low price and advised the person not to buy. So why did I tell him not to buy?

Firstly, shares are typically listed on the Nigerian stock exchange at what is called a nominal price per share. A single share of Dangote Cement for example is listed at 50kobo per share as nominal price but valued at N166 per share (as at current price). Most stocks on the Nigerian Stock Exchange have a nominal value (also called par value) of 50kobo per share. It is therefore the lowest price a single share can trade for as the share price is never below the nominal price. Now let us differentiate between a share price and the value of a share.

So, is a Kobo Stock (trading above 50kobo and below N1) stock a bad thing. Well not exactly because it could be for a good reason. But first the bad.

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The BAD

A low stock price could be an indication that something is wrong

A company can due to a bad financial year see a massive reverse in its fortunes which then results in its share price drop to as low as its nominal value if not close. Typically adverse results if not managed properly can lead to a massive loss of investor confidence leading to a mass sell off. Mass sell offs can quickly erode the value of a stock.

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Bankruptcy & Liquidity Crisis

Companies that are not able to meet their immediate financial obligations can be exposed to Bankruptcy. Once bankruptcy sets in, the company is seen as insolvent and unable to continue its operations. In situations like this the stock market reacts in an unsavoury fashion and a sell off begins asap. Most company under liquidation or bankruptcy are most likely to trade at their nominal values.

Low share price cloud also indicate no distributable profits

Shares of companies that have negative retained earnings also have the xteristics of being lowly priced. This was the case with the company he intended to buy shares in. They had huge negative reserves that could not be turned to distributable profits in no distant future and as such no dividends. Company’s with negative retained earnings and also close to zero revenue growth are clearly likely to be trading at its nominal share price because it technically can not trade below the price.

Dividend

Companies that fail to declare dividends even when it makes profits can also be priced quite low as a punishment by the market. Whilst this is rare lack of dividend can precipitate a massive sell off and hence rapid depreciation of share price if it is perceived that the company can no longer guarantee investor returns. It could also mean that despite making profits and declaring dividends the company has no cash to pay.

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Too Many shares in issue

Very low share prices can also be as a result of many outstanding shares. Using the example above the same company with a market capitalization of N100million can have a share price of 50kobo if its number of outstanding shares is 200million. This is bad because companies with high number of shareholders are more susceptible to price fluctuations due to its high liquidity.

Low market capitalisation

A company may also be a kobo stock because it has a low market capitalisation. This may not be because it has lost value but because it is a small company and as very little net assets/equity. Companies that fall under this category are called small caps. For example a company can have N10million market capitalisation and 20million shareholders giving it a share price of 50kobo per share. Small Cap stocks whilst having potential for exponential growth very often lack to the capital it needs to grow.

The GOOD

Stock Split

A stock split is a situation where company decides to split the nominal value or price value of its stock by increasing the unit price without causing any dilution. For example a company has an issued share capital of N1million represented by a unit price of N1 and 1million shares. It then decides to split that unit price by half resulting in 50kobo unit price and 2million shares and N1million issued share capital. Essentially, whilst the value remains unchanged, the unit price and no of shares increases pari passu. Companies carry out stock splits if the want to increase the number of shares in the company and well as reduce the unit price. Usually when stock splits are carried out the market price also splits in relation to it nominal price. As above, if the share price was N8 before the split it halves to N4 after the split.

Bonus Issue

A bonus issue can also affect the unit price and sometimes value of a stock. When a the quantity of shares in issue is increased because of a bonus issue it is likely that the share price will reduce especially if it was always single digit. For example, a stock trading at N1per share that carried out a bonus issue of one for one will most likely have a marked down price of 50kobo per share.