They Should Buy-Back

Maltastar 

 

In the little free time I find, I read about financial crisis or scandals that inevitably from time to time hit the headlines of the financial press and sometimes, when their dimension is thicker, of the general press as well.

Presently I am reading a book titled “When Genius Failed” that gives a detailed account of the rise and fall of LTCM between 1993 and 1998. It describes how the Russian default in August 1998 ignited a global run to quality that nearly brought the collapse of the entire financial system as all investors rushed out at the same time and could not go through the narrow door without fatal consequences.

“The equities listed on the MSE have taken a beating especially during September.”

The international investment world is currently going through a somewhat similar experience. Investors are rushing to quality abandoning equities and low-grade bonds and taking shelter in qausi cash investment and quality investment grade bonds. Security is attracting priority over the return expectations.

 

 

A faltering economic recovery, a threat of war against Iraq and further terrorist reprisals that could be ignited thereby, lethargy by the ECB that continues to mis-read the sign of times in keeping interest rates too high for current economic realities, and general loss of confidence that could weaken consumer expenditure that, in the absence of investment expenditure has been the only factor to keep the economy with its nose above the waterline, are all factors contributing to the current financial crisis.

The problem with such tricky situations is that so much depends on confidence that a prospect of a crisis could itself become a self-fulfilling prophecy. And this grave risk is prevalent in Malta too.

The equities listed on the MSE have taken a beating especially during September. The return from summer holidays has brought only sellers to the market. The index has now fallen nearly 25% this year, which added to the losses experienced in 2000 and 2001 cannot but weigh on consumer sentiment impacting the overall economy.

“If the directors of listed companies really believe that their companies are worth more why not put their money where their mouth is and buy back their own shares at bargain prices”

Admittedly this is not dissimilar to the experience of other international exchanges. But this is no consolation. And yet there is an important distinction that separates the experience of our investors from that of investors in foreign countries.

The culture of share ownership in foreign countries much pre-dates the local one. Foreign investors who are being hurt by the downturn probably enjoyed the good times of the 90’s when stock exchange indices skyrocketed. Consequently many foreign investors are only giving back what they had previously gained; serious but not disastrous.

Many local equity investors, on the contrary, entered the market after it had peaked towards the end of 1999 and the year 2000. Daily I hear of painful stories of how unsophisticated investors who had no idea of the risk involved in investment equities were persuaded by young bank front-liners, especially in the first half of 2000 when new equity – based investment products were launched, to switch their hard-earned savings to equities, directly or through collective investments schemes, on the premise that their successful run of 1999 could be perpetuated into the future.

Which means that many local investors have only the pain to show for their equity investment on the Malta Stock Exchange and they are probably all rushing through the exit door causing prices to fall well beyond their fundamental values. We have reached a stage where certain equities are nearly on par with their Net Asset Value in spite of the fact that the listed company returns a double-digit percentage profit on its equity base. A stage where the dividend payout is higher than the interest rate obtainable from short-term liquid investments.

 

 

Basically it means that certain equity prices have fallen into deep bargain territory but because of the risk averse sentiment that has been built by the negative experience of the last 30 months, investors will just not consider additional equity investments at any price. Investors are trying to move out when fundamentally they ought to be moving in. However, no one wants to be the hero and invest in a falling market.

There are two schools of thought on how to address the situation. The laissez faire school favours the do nothing approach. Let the market take care of itself. Finally they argue that prices will fall to a level low enough that real professional investors will not resist the bargain and the buying begins. In the process, unsophisticated investors will get burnt out, killing the dream of having a culture of popular share ownership and needing years to re-build confidence in the markets.

The other school is that the corporations that are listed on the markets have a duty to protect the value of their shareholders’ investments and when these reach a level where the market price is at a substantial discount to the fundamental value of the equity, they have an obligation to invest in their own shares by launching buy-back schemes.

If the directors of listed companies really believe that their companies are worth more why not put their money where their mouth is and buy back their own shares at bargain prices. This is especially so where the companies are cash-rich and do not have immediate investment plans giving better value for their liquid resources.

I consider that even small buy-back programmes would be enough to send a signal to mad rush out of equities that investors ought to reconsider. It will bring back sobriety to the market. The signal buy-backs would send is much more potent than the amount of money which is set aside for such buy-back programmes.

In the interest of the small investor and the long-term health of the market, management of quoted companies have to stop sitting on their hands whilst watching their shareholders value melting away.