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Friday, March 24, 2023

NSE-to-GDP Ratio Shows Shallow Nature of Equities Market

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It is important that policy holders formulate transformation policies that will deepen the capital market as Nigerian stocks are ridiculously undervalued when compared to peers in Frontier and Emerging markets.

The country’s market capitalization to GDP ratio currently stands at 19 percent, that is abysmally poor and lags South Africa, 327 percent; China, 44 percent, and Russia, 53 percent.

The data reached an all-time high of 29.7 percent in Dec 2007 and a record low of 3.0 percent in Dec 1985, according to MoneyCentral’s trend analysis.

The Nigerian Stock Exchange (NSE) provides Market Capitalization in local currency. The National Bureau of Statistics of the Federal Republic of Nigeria provides Nominal GDP in local currency, at basic prices.

The stock market capitalization-to-GDP ratio is a ratio used to determine whether an overall market is undervalued or overvalued compared to a historical average.

If the valuation ratio falls between 50 percent and 75 percent, the market can be said to be modestly undervalued. Also, the market may be fair valued if the ratio falls between 75 percent and 90 percent, and modestly overvalued if it falls within the range of 90 and 115 percent.

The stock market capitalization-to-GDP ratio is also known as the Buffett Indicator—after investor Warren Buffett, who popularized its use.

The majority of analysts and market participants attribute the abysmally low valuation to foreign investors’ apathy towards the equity market and the difficult macroeconomic environment.

“A number of companies do not see the incentive to list especially now that the macroeconomic conditions are unfavorable,” said said Gbolahan Olugunro, equity research analyst at Cordros Securities Limited.

“There is no need raising capital at a cheap rate when the demand for products is low and production is being hampered by insecurity, infrastructure bottleneck, and foreign exchange challenges,” said Ologunro.

Ologunro added that the cost of listing on the exchange that includes legal fees and other regulatory costs can exceed the benefits of such an exercise.

Gross domestic product grew 0.11 percent in the three months through December from a year earlier, compared with a decline of 3.6 percent in the third quarter, according to recent data from the National Bureau of Statistics (NBS).

“Despite the recovery, the fragility of the state of the economy was reflected in the fact that only 7 sectors (previously 9 sectors) expanded in Q4-2020 while 12 sectors (previously 10 sectors contracted,” said analysts at United Capital Research.

The January headline rate rose to 17.30 percent from 16.5 percent year on year (y/y) the highest rate since Feb-2017.

Nigeria, attracted total foreign direct investment (FDI) of $2.6 billion in 2020 down from the $3.3 billion it attracted a year earlier, according to the statistical body.

Disappointingly, the Security and Exchange Commission (SEC) laments that there have not been significant increases in the number of listed companies on the Nigerian capital market when compared with peers in Frontier and Emerging markets, despite being in a position to push reforms.

The banking sector reforms of 2005 saw a significant reduction in the number of financial institutions to 25 from 89 as there were mergers and acquisition activities to salvage the ones that did not have a strong capital base to meet the requirement.

Now, the country has 169 listed companies with a total market capitalization of N20.23 trillion.

Notably, the NSE 30 firms, the list of 30 most liquid and capitalized companies that includes Dangote Cement, Zenith Bank, Guaranty Trust Bank, Nestle Nigeria, MTN Nigeria, BUA Cement, have 90 percent of the entire total market capitalization.

Of course, mergers and acquisition activities slowed on the back of the wrought brought on by the coronavirus pandemic that forced the government to impose a lockdown that paralysed business activities across the globe.

Nigerian equities have lost momentum as year to date returns are down 3.98 percent as of 2:00 pm March 19 2020, despite picking up from where it left off in 2020 (+50.0 percent) by rallying strongly in the first month of the year (+5.3 percent).

It has become increasingly clear that the equity market will continue on a downward trend as yields on fixed instruments trend higher on the back of strong demand for higher yields by investors and the need to attract foreign interest in Naira assets amid a dollar shortage.

Analysts at Chapel Hill Denham Limited have said enhancing private sector participation in the equity market may be an efficient strategy to raise capital and fund infrastructure projects across the country.

According to estimates from the Nigerian Investment Promotion Commission (NIPC), the country needs $2.8tn in infrastructure investment over the next 30 years.

Stock markets give a big boost to economic activities by creating liquidity because many profitable investments require a long-term commitment of capital. Because companies can assess long term capital through the market, there are projects for economic growth. At the same time, the government generates income through withholding tax on dividend.

Analysts say the government should unlock the potentials in the economy by removing structural bottlenecks such as the multiple exchange rate system that spooks investors who cannot repatriate their money and the complete liberalization of the downstream oil and gas industry for better efficiency and transparency.

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