Ownership is an important element of wealth creation and it is a concept everyone needs to work towards and aspire to today. Ownership represents a person’s ability and right to possess something that provides the potential for financial security and wealth irrespective of one’s age. It can come in many forms and as assets such as land, a business, precious stones, or financial instruments such as bonds, treasury bills, or stocks.
For a person above the age of 16 and born into the Millennial (1981 – 1996) or GenZ generation (1997 – 2012), it is vital that ownership be taken seriously and adopted early regardless of how much income they make. This article aims to shed some light and provide a framework on the concept of stock ownership and how one can value and select stocks on the stock exchange today.
What are stocks and why should you buy and hold them?
A stock also popularly known as a share is simply a fraction of a business or publicly traded company that is owned by an individual, group, or corporation. Stocks are traded on stock exchanges like the Nigerian Exchange Group (NGX), in Nigeria and globally via stock exchanges like the NYSE, NASDAQ, LSE. For individuals, just like you and me, who want to buy stocks, we can do so via a stock brokerage firm, many of whom have both physical and online presence today.
The ownership of a company stock entitles an owner of a stock to a portion of a company’s assets and profits based on the number of shares that are owned. Buying and holding a stock can be very profitable and provide the stock owner with a means to compound and accumulate wealth. An example of accumulated wealth through stock ownership in Nigeria can be seen in Jim Ovia, the Chairman of Zenith Bank Plc, who owns 2 billion Zenith Bank stock. In every year for the last five years, Zenith Bank has paid its shareholders ₦ 2.5 per share in dividend (i.e. share of profit) which for Jim Ovia, amounts to ₦25 billion in profit in the last five years, without selling a single share that he owns.
When it comes to ownership of a company’s stock profitably and sustainably, it is required that one has the ability and skill to properly value and select the right stock. The best way to value and select stocks involves a combination of qualitative and quantitative analysis. The next section will provide you with a proper way to perform these analyses to own the right stock in Nigeria or anywhere in the world.
Qualitative analysis of a stock
Qualitative analysis of a stock involves the analysis of qualitative information (i.e. Qualitatives) of a company. When it comes to a company’s stock, we define qualitatives as that non-numeric information that enables a stock investor to properly get a sense of the nature and value of the company stock they wish to buy. The major qualitatives of a company that needs analyzing include business model, brand value, corporate structure, and competitive advantage. Here is what you need to know about analyzing qualitatives:
- Business Model: The business model is simply how a company makes money and returns from the products or services it offers to consumers. When analyzing a stock, it is important that you know how they make money, which products or services they sell, and whether consumers pay for such products or services. Take a business in banking like GTB or UBA, for example, their core business model involves the collection of customer deposits and loaning those deposits to businesses at an interest. Any company stock that doesn’t have a clear business model should be avoided.
- Brand Value: The brand value represents the image and identity of a company and how they are perceived by consumers. When performing qualitative analysis, it is key that you access and pick a stock that has an image of the entire company and products or services that are valuable and in demand by consumers. An example of companies with great brand value is Coca-Cola, Access Bank, Apple, MTN, etc.
- Corporate Structure: When you are assessing the corporate structure of a company, your focus should be on the company’s governance, management and culture. A company should be run and managed by people with the right expertise and under the right environment that can and should guarantee steady profits. If a technology stock like Google for example is being run by a tailor, that should be a red flag to you as an investor.
- Competitive Advantage: The competitive advantage is a very important qualitative mainly because it gives you insights into the edge the company has over its competitors. In selecting a stock, you want one that has a huge and comfortable market share, a case in point is that of Dangote Cement’s dominance of the cement industry in Nigeria. This allows the company to dominate most of all the profits that exist in the cement market, which is great for an investor.
Quantitative analysis of a stock
Quantitative analysis of a stock involves the analysis of quantitative information (i.e. Quantitatives) which are embedded in a company’s financial statements. Quantitatives are majorly in the form of numbers and metrics and proper execution of quantitative analysis will depend on your ability to analyze core parts of a company’s financial statement such as the balance sheet, income statement, and cash flow statements of a company.
The goal of quantitative analysis is for you to break down a company’s financial statements into important metrics that can help you access the health of a stock to keep being profitable. While this endeavour can be quite challenging for someone without a finance or accounting background, they are nonetheless easy to grasp. The major quantitatives you should focus on are:
- Stock Price: The price of a stock, also known as the share price is the cost associated with buying a single stock. The stock price is usually the first major criteria you need to consider when buying a stock and must be considered alongside other important variables as provided below. When choosing a stock, it is important to choose those with prices that are sensible and not highly inflated when compared to their earnings, book value, or assets.
- Dividend Yield: The dividend yield of a stock represents the amount of profit allocated to a stock owner when compared to the price of a stock. As a stock owner, your main aim should be to prioritize stocks that can pay you ample dividends as well as a good yield that should validate the reason for buying such stocks in the first place. A good example of a dividend-yielding stock in NSE is Zenith Bank, which has paid a yield of 10-13% every year to investors for the last 5 years.
- Earnings Per Share: The earnings per share of a stock represents the profits associated with such stock in a particular year for every share outstanding (i.e. all company stocks made public). When choosing a stock, it is vital that it’s a profitable stock and has been profitable for many years, if not there is no point in owning such stock in the first place.
- Price to Earnings Ratio: The price to earnings ratio represents the price you pay for each earnings per share of a stock you aim to own. When buying a stock, it is logical to choose a stock that has the right balance between the price in the stock market and the profits it makes for you per share. Your job as a stock owner is to avoid overpriced stocks compared to their earnings and rather go for undervalued and underpriced stocks, which usually provide the best return on investment.
- Book Value Per Share: The book value per share represents the true value of a stock. The book value is what is left after liabilities and debt have been removed from assets. As a stock owner, it is key that you select and choose stocks that are rich in book value as that represents the true worth of a stock after liabilities and debt are taken out of the equation.
- Free Cash Flow Per Share: Cash Flow is the lifeblood of any business and that means that a company that cannot generate enough cash flow is bound to fail. As a stock investor, your aim should be to value and select stocks that are rich in not just cash flow, but free cash flow. Free cash flow represents the cash flow left after capital expenditures in things like property and equipment have been subtracted. A stock that has enough free cash flow consistently is a stock that is healthy and worth your investment.
- Debt to Asset Ratio: One of the main themes when owning a stock is that it should never be indebted above its assets. The debt to asset ratio of a stock shows you how much debt a stock has compared to its assets. As a rule of thumb, the stocks you should own must have a ratio below 1 and any stock with a high debt level above asset should be avoided.
There you have it, with the information above you now have a simple framework from which you can competently value and select stocks today as a Millennial or GenZ. It is important to take a bottom-up approach when analyzing the stock you wish to own, and also to make sure that when performing such an analysis, you compare the stock of interest to its past data, competitor’s data, and economic data.
Stock ownership is an integral part of wealth creation and the information above will enable your journey towards wealth on the stock exchange today.
Franklin Hodgins Ebomah is an Analyst & Writer focused on interest areas such as Finance, Energy, Tech and Geopolitics. He is also the author of a book called ‘Value Investing Tip Book’ which is a simple and straightforward guide for anyone interested in investing in stocks.