The Guyana Stock Exchange and the market’s non-efficiency
It is nice to see that the Guyana Stock Exchange (GSE) has a new and improved website. The contact details of three brokerage houses are clearly displayed, making it easy for old-fashioned investors to buy and sell their shares. The price-to-earnings (PE) ratio is provided for all the traded companies. Some amount of financial data is available for each traded company, but it would further help decision making if the potential investor had a quick look at the debt profile of the companies.
Relating to the PE-ratio, it is a very useful first-glance measure when considering whether to buy or sell a company’s share (or stock). The PE-ratio can provide hints of whether the share is overvalued or undervalued – important information for stock investing. PE-ratios can also provide information on the long-term growth prospect of a company. However, I would argue that in the case of Guyana, one has to be nuanced when considering the PEratio.
Take, for example, the PE-ratio of Demerara Distillers Limited (DDL) that amounts to a whopping 67.5 in the last updated trade (at the time of writing, July 11). The last updated trade for Banks DIH Limited indicates a PEratio of 29.3 (a quite high ratio, also July 11). It should be noted that Banks DIH has a slightly higher dividend yield (0.7%) compared with that of DDL (0.4%). Do these two pieces of information imply that investors should sell some DDL shares and buy Banks DIH’s?
Yes, I would say. However, this does not mean that DDL is a bad company. The fact that its share price is so high relative to earnings indicates that investors value the company highly. Nevertheless, an investor can make more money in the short term by selling DDL and buying Banks DIH. However, DDL has several long-term plans for growth, such as a potential dairy linkage. This implies that DDL is possibly worth a higher long-term PE-ratio than DIH, but not a ratio of twice that of Banks DIH. Moreover, active buying and selling on the market will enhance liquidity. Overall, as an investor, I would want to have both of these stocks in my portfolio since the companies are part of a duopoly with significant pricing power.
The website of the GSE could be improved by better reporting a composite stock index. Yes, there are lots of important datasets on the new website. However, it is not possible to have a continuous view of a composite index since the trading started in June 2003. Mr. Rawle Lucas has done important work over the years producing a composite index, which is published weekly in this newspaper. However, having this series available for a long period of time is very important to judge the overall health of the market and calculate long-term return on various stocks.
To be fair, the GSE website does provide a discontinuous market capitalisation in HTML format that combines the price of each share and the volume traded. Recently, it was reported that the total market capitalisation of all traded firms reached G$1 trillion (US$4.8 billion). If an investor wants to obtain a composite price index he or she will have to conduct several stages of computation such as (i) calculating the unit price for each company from the company’s market capitalisation; and (ii) figuring out a weight for each company in the composite index. I do believe that this is an important service the GSE should provide in order to facilitate quick decision making on stock trades as its services continue to improve. Having this information readily available could also enhance market liquidity.
Another useful piece of information an investor would need in making an informed judgement is the company’s beta. If the composite index is available and the price of each company over a long enough time period, one can calculate this beta parameter. The beta is a simple and useful quick measure of the risk associated with each stock. We observed earlier that DDL’s share has a significantly higher PE-ratio relative to Banks DIH’s. However, how risky or volatile is the share price of DDL versus Banks DIH? We should know the beta of each traded firm on the market. The GSE already does important work by providing the PE-ratio for each company on the exchange.
Yet another useful bit of information for researchers and investors is the alpha of a company’s stock. The alpha is usually calculated for a portfolio of stocks relative to the overall market. However, nothing should preclude a Guyanese researcher from calculating the alpha for each traded company on the market. The alpha parameter tells us whether one company’s stock is systematically giving a higher return on investment in excess of the overall market. In other words, is the rate of return on Demerara Bank Limited’s share consistently higher than the rate of return on the entire stock market index? Is the rate of return on the share of J.P. Santos & Company Limited consistently higher than that of the entire market?
Economic theory tells us that if the stock market is efficient, then the rate of return on a company’s stock or a combination of stocks (a portfolio) cannot systematically beat the market return over the long term. It is possible to beat the overall market for a short period of time, but not systematically year over year. This is because the price of a stock ought to reflect quickly all public and private information regarding the health of a company and its interaction with the macroeconomy. The latter is the awesome information processing function of an efficient market.
If a company’s share price has a high alpha (excess return), a continual process of arbitraging will take place in the market causing the excess return to disappear and move back to normal returns. The arbitrage and the rapid information processing of an efficient market mean that the alpha of a share should be fleeting.
A visual inspection of the historical market capitalisation tends to suggest that the returns are not random enough – hence, the Guyana stock market is not efficient. However, a visual inspection should be no substitute for a more rigorous study of the stock market’s efficiency. I hope the good people at the GSE would conduct an intense study of the market efficiency because it has implication for both policy and capital market development in Guyana. A well-functioning stock market, as well as a bond market, will be an important pressure valve for real estate prices and the foreign exchange market as the government – flush with oil windfalls – increases the size of the annual budgets.
A stock market that is not efficient has important social implications in a country like Guyana. It means some people have access to privileged information and can therefore earn high alphas. Furthermore, the privileged information implies that the market return is not random and can be predicted enabling those with access to earn higher returns relative to those without similar privilege. Like the scandal in the London Interbank Market, nonefficiency might also imply price collusion which ought never to take place in a stock, bond or money market.
One of the wonderful things about well-regulated efficient markets – unlike monopoly, oligopoly and monopsony structures as well as private capture of government – is each market participant has equal footing to compete. Everyone has equal access and everyone must do his or her homework to succeed. Rent seeking does not exist in efficient markets. But government has to establish the foundation.
Comments: tkhemraj@ncf.edu