The Optimistic View of Capital Market – “Cash A/C Dr…. XXXXX To Capital A/C….. XXXXX”

The Optimistic View of Capital Market – “Cash A/C Dr…. XXXXX To Capital A/C….. XXXXX”

I studied my first lessons of double entry book keeping system when I was in grade 8. The whole system of double entry book keeping enticed me then and till now my profession has been around it, day in and out. The first accounting entry that I learned was:

Cash A/C Dr (Debit) ………………  XXXXX

     To Capital A/C ……………………………. XXXXX

As a learner, I had absolutely no idea how important this accounting entry was to a company and the economy as a Whole.

About a year ago in a podcast “On Air with Sanjay” Mr. Saurabh Jyoti had a remarkable statement, the glimpse of which was all over the internet. In Mr. Jyoti’s words “Mr. Ram Bahadur a common Nepali, wakes up on alarm clock which is made in China, goes to kitchen pours himself a bowl of cereals “Kellogg’s” which is made in US, puts on a Jeans “Levi’s” and a Shirt which is made in Bangladesh, goes out on a Motor cycle which is made in “Japan” searching for a job. Whole day he searches for a job, comes back tired sits on a sofa which is made in Malaysia, pours himself a glass of French Wine puts on a pair of slippers made in Brazil watches TV which is made in China and wonders himself why he cannot find a good paying job in Nepal.”

Mr. Jyoti had made the statement with regards to Nepal’s trade deficit and Nepalese consumer behavior and every word of him is absolutely right.

Now, just imagine in that world of Ram Bahadur where there is no capital injection by any Nepalese businessman. The alarm clock made in China, Kellogg’s, Levi’s, shirts, sofa set, motor bike or anything which is made outside would have no market in Nepal as there would be no importer importing the goods, no transporter transporting goods from the boarder to the store, no dealer, no whole seller and no retailer selling to final consumer. This imaginary world was actually a reality until some generation from now in our country and the situation is still true for some communist countries which till date is not open to Global economy. People do crazy things with their money, but no one is crazy. The only reason why the capital injected in bringing in these goods into Nepal is not routed to producing these goods in Nepal is that the business of buying and selling (i.e trading) is more beneficial than investing in manufacturing or production sectors. The down side risk of losing it all by investing under a high leverage scenario (situation of higher debt fundings) with instable and usually upsurging interest rates is higher than the upside of gaining more though manufacturing than trading.   

For a generation of my grandparent’s alarm clock, Kellogg’s cereals, and motor bike were all luxury products and the luxury of these products were only entertained by them as an elderly when my dad brought in some extra cash after fulfilling family’s basic necessities. The situation is similar with majority of Nepalese family. The money earned by grandparents were all used for family necessity and even if they had some extra cash it was invested into lands used for agriculture. In our parents’ generation the banking system was widely introduced to the society and what little they could save started going towards the banking channel. The society found a one extra means of investment in form of fixed deposits. In both the generations those who succeeded financially with flying colors or failed miserably had in one way other had invested into business/ businesses or injected capital into their venture. An alarm clock, a bowl of Kellogg’s, a pair of “Levi’s”, a Motor Bike, an imported sofa set, a pair of slippers and even a French wine are all in our easy reach today as a visionary entrepreneur among our grandparents or our parents who thought it was necessary to inject capital into a business of these products would yield good profit opportunity in the future. So, for any economy capital invested into businesses is very importance and the capital market is a tool that attracts the capital from public as a whole.   

Me being optimistic about the future of Nepalese Capital market has a lot to do with the research of economists Ulrike Malmendier and Stefan Nagel from the National Bureau of Economic Research of United States who dug through 50 years of the Survey of Consumer Finances in 2006 and published “a detailed look at what Americans do with their money”

According to the economists: “In theory people should make investment decisions based on their goals and the characteristics of the investment options available to them at the time. But that’s not what people do.

People’s lifetime investment decisions are heavily anchored to the experiences those investors had in their own generation—especially experiences early in their adult life. If you grew up when inflation was high, you invested less of your money in bonds later in life compared to those who grew up when inflation was low. If you happened to grow up when the stock market was strong, you invested more of your money in stocks later in life compared to those who grew up when stocks were weak.”

The economists wrote: “Our findings suggest that individual investors’ willingness to bear risk depends on personal history. Not intelligence, or education, or sophistication. Just the dumb luck of when and where they were born.”

Now, look at this generation: very passionate about stock market and has been fed into the idea: don’t work for money but make your money work for you. This generation has been actively investing in equity, taking risks, trading on shares, carving for tips which could give them a good breakthrough. This is why the number of Demat accounts have totaled to 55,90,396 with 46,69,706 Mero Share users and 9,75,50,29,564 no of shares in dematerialized form as I am writing this article on 15^th March 2023 and the number is increasing day by day. Oversubscribed IPO’s, increased numbers of active investors and traders, increased daily transactions definitely hints what the people of this generation are doing with their money. If these people in their early adult life are forming capital out of their life time of personal and family money, this is a great news for the future of our capital market. Investing in capital or equity means being paid at last in the value chain when everyone else has been paid like payment to employee in form of salary, payment to bank in from of interest, payment to debtors for goods and services, payment to government in form of taxes. This generation has already prepared itself in taking risk and understanding the mechanism of capital as a leverage. This will have a huge impact on the future of capital market and here are some of the optimistic predictions related to Capital Market:

1. Nepse will have a competitor:

NEPSE opened a door for both individual and corporate investors to participate in the secondary market. The modern financial system offers opportunities like day trading (trade within the day and gain or loss based on the price fluctuations within the day), derivatives like futures (buy or sell today and square off in future dates) and options (option to buy, sell or do nothing), short selling and many other opportunities which allows investors to minimize their downside risk of any investment. The investor in Nepal do not have any option rather than to look at their portfolio go down during bear cycle. NEPSE has not been able to catch up with time and provide the investment community with the latest market trends. Also, NEPSE is not able to segregate the trading and investment platforms.

There is difference in objectives between Trader - who wants to earn profit and Investor – who wants to maximize wealth. If NEPSE can provide platforms like day trading the traders will be engaged in the day trade without disturbing the price movement of the shares.

NEPSE seems stagnant in bringing innovation and wide range of packages to its investors. There is an inflated demand from the investment community to move to modern financial system and having a competitor will trigger for a change.

Many still believe that NEPSE can still adhere to modern financial system. But I see a fundamental bottleneck to that because structurally almost 59% of the ownership of NEPSE he held by Government of Nepal and the government has even bigger problems than capital market. On top of that capital markets can best perform when there is more freedom in the system.

Source: NEPSE Official Website

NEPSE has provided return of 100% for couple of years now and in past few years has provided good returns to its investors. For Government of Nepal where majority of the entities under their portfolio are loss making entities, the Government may tend to psychologically focus more on reducing the losses of those loss-making entities rather than focusing on entity already making money for them.

No matter how many changes NEPSE has brought in over the course of time, it’s still short from the need of investors to experience the perks of modern financial system. Having a competitor will make a real difference, the capital markets will compete among them to attract the larger investment community. The market that can provide best services will have more investors investing in it.

Having multiple capital markets is common in every free capital markets. As per SEBI, in India 6 recognized stock exchanges have permanent recognition, Metropolitan Stock Exchange of India Ltd. has validity upto 15^th September 2023 and 28 stock exchanges have been granted exit.

Having a competitor for NEPSE will be good for overall growth of capital market in Nepal and also blossom good finance careers of finance professionals.  

2. Big Businesses will open doors for Public

The security Market was established in Nepal in 1985 and Nepal Stock Exchange Market was established in 1994. Yet, Big business houses like Chaudhary Group, Golchha Group, Bishal Group, Jawlakhel Group, Khetan Group, MAW enterprises, Vaidya’s Organization of Industries and Trading Houses (VOITH), Dugar Group, Jagadamda Group, Triveni Group, Deurali Janata, Rajesh Metal Craft, Kalika, and many others have not felt comfortable in raising funds from public.

The reason being these companies have no need to raise fund from public and once the company turns public it most undergo many compliances and financial disclosi. These groups will not change their suffix from “PVT LTD” to “LTD” until and unless it’s of some benefit to them.

There are few points to support why big businesses are going to be Public. First thing, with introduction of Nepal Financial Reporting Standards, all the corporate bodies not defined under Small and Mid-Sized Entities (SME’s) or the entities who have public accountability (Borrowings > 50 Cr, Balance sheet total > 1 Arba, Avg. Employees > 300, Annual Turnover > 1 Arba or Holding Assets in Fiduciary Capacity). There is high chance that most of the companies within the groups mentioned above have public accountability by any of above reasons. So, even when the suffix is PVT LTD, the disclosures of financial statements must be line to a Public Company. If the companies are any way disclosing financial statements in line to what public companies are, then why not take advance of market capitalization of own companies.

Source: ICAN Website

Secondly, many of the leader leading above groups will play vital role in establishing Nepal’s second stock exchange. If you have noticed the capital structure of NEPSE, the leading private sector are not part of NEPSE. Any new Stock Exchange that will be established will have good percentage of ownership of the leading private sectors. So, when stock market is itself owned by these private sectors, they will definitely be part of it.

Third and most important, till date the only person listed in Forbes list of billionaires from Nepal is Mr. Binod Chaudhary as of 15^th March, 2023 he stands at 1929^th richest person of the world with Net Worth of $1.5 Billion. After, certain level of money, the satisfaction of money slows fades and people tend to psychologically move towards power and prestige.

Now, Mr. Chandra Dhakal can be a game changer and can play as catalyst to promote conversion of Private entities to Public. To understand why, we have to understand how Forbes compute the Net worth of a person. As per 2022 Forbes 400 Methodology: How We Crunch the Numbers “We took into account all types of assets: stakes in public and private companies, real estate, art, yachts, planes, ranches, vineyards, jewelry, car collections and more. We factored in debt and charitable giving. To value private businesses, we coupled revenue or profit estimates with prevailing price-to-sales, price-to-earnings or similar ratios for similar public companies and applied a 10% liquidity discount. For venture-backed companies and other businesses that had not recently sold equity to investors, we adjusted based on how the sector in which they operate has fared in the time since their latest funding round.”

Source: FORBES Website

Now, if we assume that Mr. Binod Chaudhary turns his company public and the security Market would value his company as much as the valuation from Forbes, he would still be 10% richer on the value of his private company’s valuation (as 10% liquidity discount is applied on his valuation of private company). Suppose, the 10% liquidity discount on valuation of private companies makes only $0.1 Billion, then he would climb the stairs from 1929^th richest to 1818^th richest person in the world (because there are 111 people holding the same position) and if the 10% liquidity discount on valuation of private companies makes only $0.2 Billion, then he would climb the stairs from 1929^th richest to 1729^th richest person in the world.      

Majority of the holdings of Mr. Chaudhary is on private companies.

Source: CG Website

Why I say Mr. Chandra Dhakal will be a game changer is that majority of his holdings are listed in NEPSE and if his name somehow come to FORBES list of billionaires, then the businessmen of Nepal will start lining up to get their company public.

Just imagine if Unilever Nepal Limited (UNL) is valued at 20,145 (as on 2023/03/15) per unit of share how much could UDN (flagship company within Vishal Group’s FMCG distribution vertical),

Source: UDN Website

if HDL is valued at 2,100 per share how much Jawalakhel or Khetan Groups companies would be valued at. If these people let the market decide the worth of their company, their Net worth could be way more than what valuation models have to offer. Except for few insane instances (like Facebook valuing WhatsApp based on number of customer base), the market has always been a better place to decide a better price as the investors invest on future expected returns rather than looking at what companies are making today. This is why CGH which is going on a loss in its financial statement is valued by market at 1,144 per share. Majority of listed hydropower companies have book value less than the per unit offered to Public during IPO, yet they are valued by market insanely high.  

Capital market will be a Powerful tool which will help even the richest person in Nepal climb the stairs of the Forbes List. So, big companies will eventually come to the market place and this will be a huge turnaround for our market, investment community and the companies.

3. Hydro – “White Elephant” for Government

In business term White Elephant means the asset, property or business that is so expensive to operate and maintain that it is extremely difficult to actually make profit from it.

Currently, Hydro Power projects have 30 to 35 years license agreement with Nepal government. Many experts believe that the life of the projects can be at minimum 50 years and there are examples of well-maintained hydro power projects operating over 100 years. After Power Purchase Agreement and license period expires there is uncertainty of ownership of these projects when less than half of its life has been operated.

If we step into the shoe of the government, they have option to either take the full ownership of the hydropower or ask the entities under its control like NEA to take over the projects and manage the projects. In the age when government is privatizing its entities and diluting its holdings on public entities, nationalizing these hydro power projects will not be a good idea for government. More over NEA will be busy focusing on providing healthy transmission and distribution of electricity and why would it put its nose on entities that can be better managed by the private organizations specially when NEA would be earning well by transmission and distribution. If government tries to manage these projects, the government has to invest on human resource, better management and make sure that these entities will still make profits. The biggest resource of Nepal that has capacity to turn the tables for our economy could be a white elephant as the government may not be in the better position to manage these projects than those who built it. Also, Government can still make money using other tools like Royalty fee, though which it could be benefitted well rather than taking a risk and headache managing the companies. So, Government is more likely to decide a certain royalty fee on sale of the power and ask the existing management to manage the projects, which will be win-win for all.  

As an investor of the projects who have invested on the project estimating the Present Value of future cash flows of 30 to 35 years, the benefit of earning the future cash flow over the course of the whole life of the project will definitely be worthier.

4. Capitalized Packages of Illiquid Assets and Renting of shares

With time the capital market will adopt the modern financial systems. There will be competition among the stock markets, the brokers, the investment bankers and every finance profession. This competition will lead to many opportunities. One of that will be that the illiquid assets like land will be converted into packages which can be capitalized and sold in the security market. Not just land we will see the rise of derivative and commodity market where people will start covering the security risk with the commodities of daily use like vegetables, oil, gas, gold, silver, currencies and everything that has value.

Also, the traders will start renting shares from the investors, give investors back the number of share they had initially taken and pay them the rental fee for use of their securities. For example, if I am holding share of Nabil and I am planning to hold it for 10 years my friend will request me if he can rent these shares from me, he will take the benefit of either long position (buy first and sell) or short position (sell first and square off later) on Nabil and gain trading income on these positions. My friend will give me back my shares of Nabil Bank along with some rental fee for using my shares to make trading gains. Today for NEPSE and many investors, these things look so insane but these all things are legal and many securities markets practice these methods.

To understand what capitalizing the illiquid assets means we have to understand some economics behind it. For example, for few decades ago buying land in Kathmandu valley meant buying ropanies or aanas of the land. Then eventually demand for land increased drastically and the cost per aana increased rapidly. So, people could not buy the ropanies of land. To meet up with the increased demands, the property developers started buying huge properties, then develop those properties and make small plots of 4-5 aana which people could afford. The supply for the huge demand was fulfilled and the price of land has been consistently increasing. But, the nature of land is that it is constant and the demand is always increasing due to population and migration. So, we all know that the property market will always be profitable and we all want to invest in the properties but we do not have money. We will reach to a situation that paying for 4-5 anna of land will also be very-very costly (even today the properties of prime locations like New Road and Asan is very expensive and we cannot get even 1-2 aana of land in those areas). Investment bankers are smart and they understand that to fulfill the demand of the property they have to further decrease the units so that people can pay the price they want to. But, the governments restrictions will not allow physically cutting the size of the plot. So, a new trading package in form of land will be developed. Like NABIL is the share of Nabil bank and traders play on the differences in the price of share of Nabil banks, there will be new strips like PPNEWRoad (Property Price New Road), PPNEWBaneshwor(Property Price New Baneshwor). These strips will be listed on the security or commodity markets. These securities will be valued on per dam or even smaller units like 1,00,000 per dam which the trading community can easily pay for. The investors who actually wants the hold the property physically will only buu the property and remaining trading community who want to gain on the value of land during a certain period will take a long or short position as per need. By that they can gain on the value of properties without actually holding the land, they can profit when prices go up or down.

This is how in the future illiquid assets will also be converted into liquid securities. This can happen not just in land, everything you can think of gold, silver, currencies, dollar, rice, sugarcane, oil, gas, electricity everything can be converted into securities and these tools will be used by the traders to cover their downside risk of loss on a particular stock.

5. Capital Market will also be wealth creator for businesses

Today the listed entities can take a route of wealth maximization objective and see the value of companies grow. But the private entities who have wealth maximization objective have to take a different pathway.  

Wealth maximization or Profit maximization are 2 basic objectives of any business. Profit Maximization is relatively short-term objective where entities will work to increase their state of profitability and distribute dividends to their investors (some portion of profit may be retained as well). For example, profit maximization entities will not invest on huge assets like Machinery and Property but take the properties and machineries on rent and gain the margins. For entities driven by wealth maximization, the net margins are relatively low due to investment in machinery and properties funded by debt. Wealth maximizing entities, derive profit just enough to survive business by paying all the loan installments. Even the small businesses like hardware’s and other sole proprietors are buying properties funded by the debt instruments and these debt instruments were repaid in monthly installments. The businesses are earning profits just enough to cover this installment payment. Over the time the businesses earn their value not though the business earnings but through the investments in the properties.

The private business will explore the idea of maximizing wealth through capital markets. These ideas will be sold by various investment bankers inform of different packages. When company is listed in stock market the shares of the company will derive values. On, top of that the company can still invest on the property, treating them as long-term investment. The secondary market investors invest in market by analyzing the Present Value (PV) of Future inflows, which for investors is the dividend. The value of long-term investments like properties are carried in financial statement at cost and do not usually increase profit due increased income but by saving rental costs. Share price usually has directly correlation to dividend distribution. When entity can provide 20% returns to its public shareholders the entity will have stable high price and the company will still be generating high value though its investments held in properties. Both the shares of the company and the investments held as properties can be pledged incase when the company has a liquidity pressure. Also, the company can explore other funding tools when its already listed in secondary markets.

The above is not the exhaustive list and we will definitely witness changes beyond our imaginations. The above changes will also have following impacts:

1. Stock Brokers will be one of highest paid professions in Nepal,
2. Bank or Financial institutions that can connect all districts of Nepal will also manage or establish a subsidiary that will manage stock brokerage,
3. Huge Capital formation not just in Stock Market even in private equity
4. Mergers of A and B to form a 3^rd entity C to maximize returns on capital of various entities rather than merger of A and B to form AB entity
5. Huge Demand of Finance Professionals for computation of Beta, portfolio risk, future and options premiums and many more
6. Capital will be a new form of leverage and the one who can give better returns on capital will be priced higher (We have already seen some hints of it in form of Mutual Funds)
7. Crowd funding will be common and entrepreneurs need not go to big business for funds,
8. Capital will change the face of our economy  

If you are still pessimistic about the economy and Capital market, I would like to explain you some-thing Morgan Housel has explained in his book “The Psychology of Money”. Mr. Housel says “Pessimism just sounds smarter and more plausible than optimism.” He says “Tell someone that everything will be great and they’re likely to either shrug you off or offer a skeptical eye. Tell someone they’re in danger and you have their undivided attention.”  

I like the way Mr. Housel has given example of Japan in his book to prove the point on being optimistic. Just imagine how Japanese must have felt post war when the country had failed miserably in every way – economically, socially, industrially, culturally. On top of that the winter of 1946 caused a nation-wide famine when food for each citizen was less then 800 calories per day. Imagine at that time if any Japanese said within our lifetime our economy will grow to almost 15 times the size it was before the end of the war. Our life expectancy will nearly double. Our stock market will produce returns like any country in history has rarely seen. We will go more than 40 years without ever seeing unemployment top 6%. We will become a world leader in electronic innovation and corporate managerial systems. Before long we will be so rich that we will own some of the most prized real estate in the United States. Americans, by the way, will be our closest ally and will try to copy our economic insights. They would have been summarily laughed out of the room and asked to seek a medical evaluation. Keep in mind the description above is what actually happened in Japan in the generation after the war.

So, dear readers if you still think there are only pessimistic aspects of our capital market here are some treat for you:

1. From 1997 Our Market has increased more than or equal to almost 200% from the last lowest point for 4 times and in 2 instances out the 4 the market has increased more than 400%.
2. You can order to buy or sell shares at a comfort of your house which for investors few decades ago was out of imagination,
3. You need not call your broker to place your orders or sought from the window outside being unaware whether the share has been bought or not.
4. You have no fear of losing your share certificates and it’s all digitalized.
5. The number of investors has increased
6. No of companies listed in Stock Market has increased
7. Overall market capitalization has increased
8. The amount of intraday transaction or turnover has increased.

These things look so obvious and are so normal and this is why optimism is so underrated. When stock market is consistent and moving ahead, we all have opinion that this is what it’s supposed to be. The positive aspect tends to be so normal in our life that we start underestimating it.

Having said all this, the market will move ahead to increase by at least 5 folds over the course of 50 years but still not everyone will win. The market is definitely headed to a right direction but can all investors be winners, the answer is “No”. If someone asks me today where can market reach over the course of 50 years? And will all current investors gain in NEPSE?? I will say NEPSE index or the main index of new stock exchange in Nepal, will reach at least to the point of 10,000/- over the course of 50 years. Now, even if the investor invests today at the market of 2,000/- and NEPSE reaches 10,000/- not all investors are going to gain or book profit. The nature of market is so tempting and hugely impacted by fear and greed. This is why we have bears and bull and this is why someone’s gain becomes someone else’s loss. Over the course of 50 years, we will see the rise of new Warren Buffet in our capital market and we will also witness the fall of big corporates due to capital markets. As market grows, the debt funding for individual investors and corporate investors to acquire capital markets instruments will also grow or the investors will be highly leveraged with margin loans. This will immensely increase the risk of investment as investors must pay the interest on debt and then gain from it. In words of Warrant Buffet “To make money they didn’t have and didn’t need, they risked what they did have and did need. And that’s foolish. It is just plain foolish. If you risk something that is important to you for something that is unimportant to you, it just does not make any sense.”

This was in 1998 in the middle of greatest bull market and strongest economy in the history where most of the hedge fund managers invested in their own fund and in the quest for more, they lost every-thing.

The one’s to win will be those understand the power of compounding and those who actually have a plan. Even when market (NEPSE) reached 10,000 we will have price fluctuations, we will have bull and bear market, economy will have recession and there will still be one or more financial problems around the economy. Investors and Traders will be playing around with fear and greed. Buyers will definitely know when is the right time to get inside the market will never know when is the right time to get out of it. Even when they have hansom return on their portfolio during a certain trade, they will still miss to book profit only due to greed of earning more and the fear of losing it all will make them sell at a point where they are exhausted of holding a portfolio at loss. It’s really important for investors to understand that the market is not going to make you rich or poor, it’s the stock that you are holding in your portfolio that will make you rich and poor. So, why you are holding certain share, how long you have planned to hold it, what are your expectations of return from that share and is that expected return normal or absolutely abnormal are really important. Once you have understood which shares are fundamentally strong, then just wait and let it grow. The winners will be those who understand, adopt and implement George S. Clason’s 5 laws of Gold as explained in his book Richest Man in Babylon.

(The second law of Gold “Gold laboreth diligently and contentedly for the wise owner who finds for it profitable employment, multiplying even as the flocks of the field. "Gold, indeed, is a willing worker. It is ever eager to multiply when opportunity presents itself. To every man who hath a store of gold set by, opportunity comes for its most profitable use. As the years pass, it multiplies itself in surprising fashion."  

And the Fifth Law of Gold “Gold flees the man who would force it to impossible earnings or who follow the alluring advice of tricksters and schemers or who trusts it to his own inexperience and romantic desires in investment.”)

In short, Capital market is at rise and will always be progressing yet few investors will be successful in gaining returns while many will fail. So, make your money work for you, focusing on compounding your returns. Also, avoid the shares that makes a news highlight, avoid tricksters and don’t expect impossible returns that will risk your return of investment while aiming huge return on investment.   

CA Bishal Ghimire