If you are a foreign investor looking to invest in a market, the first thing you might look at is availability of ‘research'.
Research at an economy level, sector level and stock level would be the first point of evaluation in what is called a ‘secondary research' process. After ascertaining the viewpoints of analysts, you might then embark on ‘primary research', whereby you form your own opinion through interaction with various stakeholders in the company.
GCC stocks have two major characteristics to note in that sense, namely that they are ‘under-researched' and ‘hard to research'. The second factor may explain the first factor, but they are not mutually reinforcing. While the ‘under-researched' status is typical of any emerging/frontier market, it is the ‘hard to research' factor that is more notably a local attribute.
Let's look at some statistics. At Markaz we publish an interesting piece on a monthly basis titled GCC Equity Research Statistics, which has identified that only 100 GCC companies have research coverage, out of a universe of 750 stocks.
In other words, only 13 per cent of companies enjoy research coverage, with Qatar the highest in the table (25 per cent) and Kuwait lowest (5 per cent). This reflection may look very discouraging, but is not out of trend.
A recent report by Crisil, an Indian credit-rating agency, stated that only the top 100 of the nearly 3,500 actively traded stocks in India receive some sort of research coverage — that's just 3 per cent!
Things look better when viewed from a ‘market cap' perspective. In that sense, there is nearly 57 per cent coverage in the GCC, with Saudi Arabia ranking at the top (70 per cent) and Bahrain at the bottom (26 per cent).
The high level of coverage for Saudi Arabia in terms of market capitalisation may be due to a skewed market structure dominated by large-cap stocks. For example, its top six companies (of a total 136) account for 50 per cent of the market cap, while the top 18 companies account for 75 per cent. In such a market it is possible to achieve scale in research in terms of market cap but not in terms of companies.
Let's examine this ‘hard to research' factor in detail.
Access to companies and their management is a primary requirement for carrying out equity research. Management discussions form an important element when deriving the recommendations to ‘buy', ‘sell' or ‘hold'.
Yet, even in situations where companies are proactively meeting analysts and providing forward-looking guidance, still it has been shown that analysts get it ‘right' only 50 per cent of the time, or even less than that.
In fact, you need the following to come up with credible research: (i) timely disclosure of performance; (ii) detailed disclosure; (iii) management discussions and viewpoints; (iv) regular analysts meetings; and (v) unbiased opinion.
On average, GCC companies take a fair degree of time to bring out their results, especially for their year-end releases (requiring audit seal).
For example, by the end of March this year, only 67 per cent of GCC companies had declared their fourth-quarter and annual 2009 results (and Kuwait only 20 per cent). That's three months on from the end of the period concerned.
Even where results are available, only high-level, top-line numbers are made available for quarterly performance, which makes it difficult to subject them to a detailed analysis.
In many cases, those data are posted as one- or two-liners on the stock exchange website (in Arabic), making it completely impossible for performance to be properly assessed.
Hence, late reporting of ‘financials' (results), coupled with weak reporting, makes it that much harder to form a credible opinion.
Annual reports are a good place to articulate management thinking and a wishlist for the future.
Famed investor Warren Buffett set a new standard of extremely detailed management discussion — now actually an international event where shareholders travel miles to listen to him and read his annual report, giving it the same respect as any other reputed investment textbook.
While it is hard to expect such levels of discussion in the GCC context, most of the management discussion (usually labelled the chairman's letter) is quite pedantic and repetitive in nature.
Analysts here are viewed more as intruders into a private world, and hence are not normally granted audience. Even if they are granted audience, mostly they end up meeting financial controllers or in a more graceful situation the CFO. Access to the CEO is at best very limited or simply not available.
Admittedly, that condition is different from market to market, with Saudi Arabia being touted as the most difficult market to penetrate and engage companies in analysts' discussions.
Where discussions for analytical research do take place, they are normally devoid of any forward-looking guidance, and may focus more on past performance. Lack of Arabic-speaking analysts, especially nationals, may be one factor in play here.
Moreover, till a few years back, it was taboo to give a ‘sell' recommendation at all, lest you run the risk of incurring the wrath of the management, manifested by sensitive phone calls all around. New terms had to be invented to replace the word ‘sell' (such as ‘caution').
For example, among the 212 research notes published in January to March 2010, only 19 were ‘sell' recommendations, while 131 were ‘buy', with the rest saying ‘hold'. In a few cases, it might be explained by a benign expectation of the stock market. But in most cases it can be taken as read that it wasn't prudent to doubt the company's share prospects.
Rapid opening up of the market to foreign investors — in terms of reducing the bar as well as the inclusion of GCC markets in the MSCI Emerging Market Index — will change this picture dramatically.
The availability and quality of research may not be the criteria for inclusion in the index, but, once stocks are included, active trading can happen only on the basis of research coverage.
Thanks to the arrival of portals such as Zawya, financial information is easy to get, via annual reports. However, a positive management attitude is extremely important, to reach out to analysts and share relevant information.
It should be noted that many listed companies are either majority family-owned or government-owned. In the past, these companies were little interested in basing their ownership structure more broadly, and indeed guarded their control zealously.
With no need to look at the capital markets as a money-raising venue, there was little incentive to meet with analysts, let alone share information with them.
Strain on resources
With banks and local shareholders more recently coming under severe strain, however, companies have had increasingly to look to diversify their shareholdings and capital-raising.
Attracting quality institutional investors (i.e., foreign), as well as considering the capital market as a viable source of both debt and equity, will be the trend in future for growth-aspiring companies. In both cases, research will form the basic foundation.
Over the past few years the presence of foreign investment banks such as Goldman Sachs, Merrill Lynch, Morgan Stanley, Credit Suisse, etc. has lent credibility to the research process.
Stock trading is a ‘daytime' (i.e., intra-day) activity for many nationals, which explains the retail nature of the GCC stock markets. Speculative activity based on inside information is quite the norm, and forms the bedrock for buying and selling. That leads to heightened volatility.
Institutional participation in trading is less than 5 per cent. Increasing research can enable this share to be increased, which can then attract more research to mid-cap and small-cap stocks, thereby propelling a "positive feedback loop".
In many markets (Kuwait, Qatar, etc.) brokers do not offer ‘sell-side' research as the investors/traders are not sophisticated enough to demand it. In addition, brokers are not equipped with qualified sell-side analysts to carry out and publish updated equity research. In most cases, they merely issue ‘flash notes' on earnings announcements.
In advanced economies, by comparison, the efficacy and utility of broker-dealer ‘sell-side' research has come in for some sharp commentary, especially relating to its objectivity. Hence, institutional investors tend to rely more on independent research that may charge for their services but at least enjoy some objectivity. However, in the context of GCC, we are still not yet there even in terms of sell-side research, quite apart from independent sources.
Looking forward, as regional market capitalisation keeps growing, along with gradual relaxation of foreign investment limits, the interest of foreign investment banks is bound to increase.
That will herald the needed research-based culture, which then will be followed by local players who until now have viewed research more as a ‘cost-centre'.
Demand for qualified and experienced analysts who specialise in GCC sectors will soar, although availability may still be an issue.
From depth of coverage, research would then progress to breadth of coverage in pursuit of ‘alpha' [outperformance], through mid- and small-cap stocks, though it may induce ‘tracking error'.
However, amid an enthusiasm to pursue breadth, companies may be tempted to outsource research to low-cost providers based in India, thereby templating the process.
Pursuit of quantity in lieu of quality would have negative consequences in the longer term in terms of research efficacy.
The consequence is that companies that are ahead on this thought-process will gain rapid market share, while the rest will bealso-rans.
- The writer is head of research, Markaz.
