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The potato expedition!!!

Imtiaz Gadar, CFA is the Head of Public Markets at Bank Alfalah, Pakistan. Previously he served as the Head of Research at KASB Securities (Partner of BOA Merill Lynch) as well as JP Morgan. He was ranked as the best analyst in Pakistan four times by Asia Money and the CFA Association of Pakistan. He also served as the Vice President of the CFA Society in Pakistan.

Disclaimer: The post has Urdu in between because English alone would not fully capture the concept. 

Recently, while scrolling through my social media account, I saw a capital markets colleague had shared a picture with his wife where both of them were out shopping. My idle mind suddenly started visualizing what would happen if us capital market folks combined our professional roles with household roles (e.g. shopping). For instance if wife calls husband and asks him to buy 2 kgs of potatoes on the way back to home.

To Kenya and back

Today I came back to Dhaka from Nairobi, Kenya. This was my first trip to Africa and despite the fact that I didn’t get much of a chance to move around, I thoroughly enjoyed my stay.

Kenya is a country of around 44 mn people in the Eastern part of Africa. Compared to the North (Muslim countries like Algeria, Libya, Egypt) and the  South (South Africa, Botswana, Namibia) the Eastern part is relatively poorer. Kenya’s per capita income of around $1,300 will put it close to that of Bangladesh.

A personal update and some career insights

Tomorrow I will start in my new role as an Equity Research Analyst (Associate Director) for Exotix. I will be covering banks across Bangladesh, Pakistan, Sri Lanka and Vietnam. For the unaware, Exotix is a frontier market investment bank specializing in illiquid bonds and loans, equities, structured finance and capital raising.

Getting a new job, particularly one with a great team and culture is quite rare. Nevertheless, the challenge lies not in getting the job but doing extraordinary work. The work of a research analyst in my opinion is like that of an artist trying to create masterpieces. You have to produce differentiated reports with unique insights and ideas before others and communicate that in clear language.

The evolution of an equity analyst

The thought processes of analysts change with time as we get experienced and learn from our mistakes. This is a natural progression even though people will definitely progress to higher stages at different times. Some unfortunate ones will however never progress to the higher stages. Based on my personal experience and books that I read here is my take on the three different stages of an analyst.

Beginner Level

The beginner analyst is usually a fresh graduate with some background of finance, economics or accounting. Even though he or she might have some theoretical knowledge of finance, they seldom can relate the theory with the practical world.

The beginner will almost always put the greatest emphasis on NUMBERS and not the story behind the numbers. Thus there will be a tendency to extrapolate past performances as that will form the strongest basis for future forecasts. Thus we will see that future gross margins are just continuation of the most recent reported gross margins.

Broad list of interviews of finance professionals

Bumped into another treasure trove while searching for something on the internet. Here is a list of around 70+ interviews of finance professionals conducted by The Guardian of UK. I read a couple of them and found them to be quite insightful. Enjoy

Things stock screens miss out

One very popular method of getting investment ideas is running stock screens. For those of you not very familiar with ‘screening’ here is a basic video. The idea is to filter out companies using basic parameters like Market Capitalization, Average Daily Trading Volume, Price to Earnings ratio to cut the investable universe to a more manageable level. Then comes a closer look like checking profitability (ROE, ROIC) , growth (revenue and earnings growth) and different valuation metrics (P/E, EV/EBITDA, P/B) to narrow the list even further for closer inspection.

However, stock screen has its fair share of issues. It is useful to know these while using screens and comparable sheets. I am in no way saying that we should avoid using screens altogether but rather saying that they should be used while remaining aware of the shortcomings.

In Defence of the Bum

There is typically a strong disgust for people who live off the largesse of the state but do not work for such benefits. Social security for the unemployed is in theory meant to be a means for sustaining individuals as they look for a job. For those whose lassitude prevents them from strenuously searching, and who take from the state through job seekers allowance, or if they have children, child benefits, or other forms of social security, these individuals are considered as societal leeches, the dregs of society, taking while not giving. Indeed if society is to function and endure it has to be assumed that its members are contributing in some form though occupation, and the production of something. That thing can be tangible objects such as buildings and clothes, or intangible things such as entertainment.

Ultimately, we are thinking that one’s worth in society is their production. When we consider factors of production, we speak of land, labour, capital, and we think of their usufruct which people benefit from. But often these factors of production can be used to produce goods and services that do not benefit people. Here we are not speaking of its potential benefits; rather it does not benefit people in that they do not demand these goods and services.

So really we are not talking about just production: production has to be demanded and used, otherwise it is just waste. In the world today, there is much waste of usufruct developed from the factors of production. In terms of land, according to a United Nations report, every year 1.3 billion tonnes of food is wasted globally, roughly one third of the global food supply. In terms of capital, China, Qatar, and other nations are guilty of building empty real estate or half-finished construction projects.  When it comes to labour, one can produce goods and services that no one wants. Countless consultants and researchers produce reports that either very few people read or do not take seriously. Academics can be considered as an exception especially those that are involved highly abstract discussions, which are intelligible only amongst those who are within that particular field. Pure mathematics is one such branch where society is not improved by the fact that some mathematician has proved a theory that predicts the number of prime numbers within a set of high value numbers.

Demand is a key factor, and society endures if there is both a supply and demand, even if what is being supplied does not necessarily produce anything tangible for society itself. Here we return to the entertainment industry and present a comparison. Sport and movie stars boast of astronomical salaries, and yet their contribution to society is abstract. Indeed, when comparing their contribution to society to a manual laborer who works on the erection of the house one stays in, can we say that Novak Djokovic really deserves $3 million for winning a tournament where all he did was smack a ball around for a few hours? One built a house in which a person stays and is provided comfort and a home that can last; the other entertained for a few hours.

Only a few people will demand the former; millions of people demand the latter, although it is difficult to see how a tennis player is materially benefiting society. The societal bum also does not materially benefit society, at least not on first glance. A closer reading shows the societal to bum to be a quite resolute member of society. He receives welfare which he spends on goods which contributes to the revenue of the company who then use it to pay their labour or perhaps on producing more goods. The company makes more money and has to pay taxes. Tax revenue goes to the government who then invest in public goods such as roads. Voila! The societal bum is an important member of society, just as movie and sports stars are. It is just that they do not put enough money into society. This is their problem. If on the other hand, a company could spend money on them, perhaps make a reality tv programme on their lives, and plaster their faces on magazines, then one could say they are contributing to society. Just look at the Kardashians!

Yet we demand to see the Kardashians. This demand reflects more on us as a society than the societal bum’s ineptitude in finding a job.  We are taught that unemployment is a bad thing for society; this misses the point. Unemployment is not the issue; the issue is whether we demand your usufruct.  The issue is whether we value your worth in society. An unemployed man may not produce for society, but his values might be better than the millionaire banker or the CEO of an international oil company. Would society be better with the avaricious CEO or the bum who does not bother and does not want to be bothered except perhaps a few pounds for some food?


Equity research – some great resources

One great thing about the internet these days is that we can sometimes find some great content for free that makes our lives easier. For budding equity research analysts, Aswath Damodaran has some really great resources. In this post I will discuss some of the resources available on his website that will be extremely useful for beginners (and maybe even intermediate level analysts).

Firstly go to his website. Click on “Tools”. Then click on “Webcasts”. The page will display a list of different topics with downloadable material and webcasts (videos). I will recommend the following ones

  1. Corporate Governance
  2. Stockholder composition
  3. Getting data
  4. From financial disclosures to value
  5. Creating a trailing 12-month financial statement
  6. Measuring accounting returns
  7. ROIC and ROE: The “only” valuation numbers that matters
  8. EV, Firm Value and Equity Value
  9. Multiples and Fundamentals – Analyzing relationships
  10. Identifying a “typical” project
  11. Valuation

The page does not offer these in the same sequence as I provided. However, I think that my sequence makes a bit of sense as it starts from the basics and then builds on to the more complex issues.

Can you double my money?

Originally published in the anniversary edition of The Financial Express

As an employee of a stock brokerage I often find myself in situations where people want investment advice. This has to be a Bangladeshi investment analyst’s worst nightmare. It is a clear case of ‘heads I win, tails you lose’ because if the advice works no credit will be given to the analyst. If it doesn’t, then may God help the analyst.

The Weakening of Bargaining Power

Venezuela is worried. Scarcity of basic items have caused consumers to queue in front of convenience stores overnight to buy milk. Hugo Chavez’s socialist ideals seem to have floundered as the social hierarchy unravels with the poorer waiting and the richer satiated. Many blame the corrupt government for siphoning money away from social services; others blame the drastic reduction of the oil price. The anchor of the Venezuelan economy has been oil, and diversifying away was never strongly encouraged, leaving the South American nation a dependent state.

It would be mistaken to think that there is one reason for the crisis in Venezuela. Corruption and decreasing oil prices have all contributed to the problem. One cannot say that Venezuela would still be suffering if the oil prices had stayed over $100 and corruption remained; none of these issues are mutually exclusive. Indeed, the economic success and sustenance of any nation is multifaceted and dependent on both internal forces (politics, commercialism, cultural philosophy, etc) as well as external (remittances, sanctions, oil prices, etc). A ruler has to be concerned with both.

Even so, the complexity of modern day markets, the intertwinement of systems, the ripple-effect ramifications of the actions of foreign nations means that nations can no longer look inside for sustenance and growth (unless you are North Korea, but as the recent Hollywood debacle has shown, they are far from being out in the cold). OPEC has shown that with reducing prices to increase supply, countries can be affected in different ways. While the US and Saudi Arabia may be lighting up a cigar with a smile on their blackened faces, Venezuela and Iran are wiping their brow.  We do not seem to live in a United Nations world.

In theory when countries trade with each other, they are making themselves better off (both countries are getting what they want).  It is the case of the market forces acting in favor of both parties. Yet this is not always the case. The bargaining power of one nation or one company can be far greater than the other, placing them in the position to dictate prices. The more powerful, in the end, have a greater say in how a transaction should effectively take place.

Thus the markets are not so benign as the theory of perfectly competitive markets would aspire for, and neither does the invisible hand exercise the best outcome where we reach market equilibrium. It is assumed that demand will meet supply where both parties are happy with the quantity sold and the price for each unit. This notion is weakened the greater disparity in bargaining power.  We see this both in the goods and the labour market and more often than not these markets intertwine.

As an example, a major brand in West wish to sell shirts. The brand shops around and finds a Bangladesh garment factory that is offering to sell shirts for the lowest cost. Higher management of the brand go to Bangladesh, accept the quality to be reasonable, and offer the contract to the garment factory. The brand can now buy at a cheaper cost but sell at a higher price. That latter price might be at a correct market price as the brand has to rely on the consumers to buy and the higher the price, the less the demand. In Bangladesh, however, the garment factory owner is thinking he wants a lot of money too. He has the luxury to push down wages to such a point as the workers are happy although not comfortable. Now one could argue that this is a market wage, yet cut the share of the profits going to the garment factory owner and transfer it to the workers wage, market wages go up.

Thus the bargaining power of the brand is higher with the garment factory, and the bargaining power of the owner is higher than his worker. Those with stronger bargaining powers can dictate terms manipulating the needs of their transactional partner. Recently in the UK, the Think Tank Civitatis was found to charge their unpaid interns 300 pounds for a reference. A graduate looking to climb the career ladder and finding options in today’s economy to be limited would begrudgingly pay (if he had the money). Civitatis would argue we are offering them a benefit, and they should pay. All that is happening is a manipulation of bargaining power.

Would we call these examples as milder forms of oppression? Many would disagree arguing that the weaker party is getting a benefit he otherwise would not have. Furthermore, by working he has the opportunity to rise out the mire of his own poverty and be able to strengthen his own bargaining power. This is a curious argument, yet one that development economists hear when explaining growth in nations. The developed world was once a drudgery with inequality far greater than today. The UK and US lived with stark class tensions with the working classes toiling while the upper classes reaped the rewards. Yet wealth trickled down changing society in remarkable ways.

One could argue this was due to the market. However, this is too simple and general an assumption. Certainly the market led to better distribution, but more importantly, it was the values of market participants that led beneficial changes. Here we are not talking about just the buyer and seller; we are talking about society in general with members invested in the distribution of social benefits. The notion of a social welfare state rests upon a polity that is looking out for their own.

The market, therefore, cannot be considered in isolation. Every market agent is member of society, and if society is to be utilitarian then the market has to be too, that is happiness for the greatest amount of people.  However, the more parochial and selfish the market participant then the likelihood is society will suffer its consequent ignominies. This is worrying if one simply considers the domestic market; it becomes are far greater concern if we increase the number of players as happens with the international market thus meaning an agent with greater bargaining power in one country can dictate the terms for his transactional party in another country who then dictates his terms to a weaker party in his own country.

In Venezuela, the above principle is manifest, as OPEC reduces its prices. Venezuela accepts the terms of lower oil prices. Corruption means the profits available go to a select few, who perhaps pay for more luxury items meaning money does not get into the domestic economy sufficiently. There is more to this story, but when we strip to the layers of complexity the basic lesson is that the greater disparity in bargaining power and the more self interested, the less likely the invisible hand will be successful as our free market proponents believe.  The values of market participants are central to understanding the markets irrespective of the laws that seek to restrain vices. But this is a story for another day.