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Sunday, October 26, 2008

There is a Problem When the DSE Looks Like This:

Notice something awkward? That is list of the largest companies listed on the DSE. However banks now dominate 11 of the top 20 spots. This is more alarming than reassuring.

The good news first. Banks are a low risk and secure investments in most countries. This is characterized by their low beta factors. The beta factor, which usually ranges from 0.5 to 3, for a stock measures its volatility to the entire market conditions. New and fast growing industries, such as software, have a beta factor of around 2, meaning if the market goes up the stock shoots up 2 times. If the market does poorly, the stock does tend to do two times worse. Old and stable industries, such as banks, have a beta factor of around 1. This makes banks worldwide one of the safest investments.

The DSE fared better in the worldwide recession because all banks had localized investments. The DSE itself is still dominated by these banks. There was no reason to panic other than to a yearning to pose like a now-trendy distressed investor. Granted these effects will likely hit the garments in six months time, but regardless of this the DSE banks won't lose 80% of their market value. That's simply because they haven't invested 80% of their money in the wrong industries. So with more reassurance and relief, people are still shielded.

Lack of Inventories
Now that most investors believe in banks is a good sign of stability and investment security. Banks dominating the stock exchanges also has to do with the nature of their business. For starters there is very little scope for accounting wizardry. Accounting wizardry's main playing field is usually in inventories. The closest thing that banks have to an inventory is 'cash'. And as you know cash is extremely easy to valuate. To realize the full potential of accounting wizardry we have to look into the diamond industry. Diamond is not a commodity and its price depends on very particular characteristics which include the shine, cut and purity. The diamond company can overstate assets and inventories as they please. And most industries extend this shining example in every way possible. But because banks lack this cloudy assets, it is nearly impossible for this magic to take place.

The second reassurance is that most banks have not reevaluated their assets. This means that the land that they paid Tk 10 lakh for in 1988, is still considered to be worth the same to the bank despite the astronomical increase in land prices. This may give an undervalued and inaccurate picture but it is better than the alternative. When a company tries to reevaluate its assets, it is considered highly controversial. Since no one has a certain valuation, the company in most cases overstate their assets justifying things like competitive-edge and potential for future earnings. This in turn ends up being more harmful and inaccurate rather than undervalued assets. But thankfully (not yet) banks haven't taken this step.

Anybody but Alamgir
The third reason that banks are dominating the DSE is that they use big-box accounting houses for their auditing instead of hiring Alamgir across the road. This is more reassuring because even though Alamgir will find it hard to apply his magic, big accounting firms will clearly look for any possible danger signals. This goes to show that despite the short term idiotic moves here and there by DSE investors, in reality they have a brain. One that works in the long term but clearly it doesn't function on many day to day issues.

The Alarm
But the domination of banks goes to show that the SEC has failed miserably. The telecoms haven't listed yet. Banglalink is not willing to list. AKtel keeps setting a year end date. And GP might list with a $1 at the rate they are slashing their IPO. This in the middle of when the entire industry now has less phone lines than earlier (how is that even possible?). While the telecom industry remains stodgy in their dry spell, the SEC continues to pursue other future Z category stocks instead of other multi-nationals like Unilever.

It was mentioned in one blog that GQ Ball Pen earned all their money in the first 6 months and had losses for the last 6, leaving very little as stock dividends. Yet the SEC continues to pursue future Z category stocks of this caliber and force them to list. The problem is not for them to list, but the fact that these list of Z-ers ask Alamgir to do their accounting holding a fat wad of cash if the magic is applied correctly. The SEC, from day 1, should simply have a list of acceptable accountants that the listed companies must use. If the accounting firm's company does poorly despite auditing then the firm should be removed from the list. What is the point of forcing to list these companies if they won't register a trade in the next century?

Recently in support of future Z-ers, BGMEA during another round table meeting asked entrepreneurs (Zers) to pursue the capital market as a source of funds. This was in reaction to banks already tightening up their belts. But the cost of asking the market to fund your company will appeal to many for the wrong reasons. Like many who have performed this extravaganza in the past, the money disappears right then. DSE still lingers of the stench caused by this bait in its nascent years.

And no one, for the right reasons, will not take funding from the market because as everyone knows, the cost of this money is extremely high when compared to a bank loan. Even in the rare case if an established entrepreneur does raise money through the capital markets he/she is more inclined to pay back the bank and himself first before paying a dividend. The entrepreneur will not care about dividends because he has got himself covered with a fat salary. So as both a top level manager and a shareholder of the company he has no intention to control the salaries paid out. To see why this is very crucial, in banks management and shareholders are in two groups. By keeping an eye on management salaries the shareholders are increasing their dividends. There is no conflict of interest for the shareholder representatives.

What we don't need is SEC to pursue a bigger version of this same capital market lie. Thankfully, as of now, this lie isn't working as evident how banks dominate the top positions. But creating a balanced market place is also necessary and crucial for the future of DSE. The SEC needs to clean up DSE's Z as well as set up accounting standards that prevent the Zs. But as usual, nothing has happened yet.

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