Why do some stock markets outperform while others struggle? We have asked this question before to explain why Bursa Malaysia — and, to a lesser extent, the Singapore Exchange S68 (SGX) — have been chronic underperformers. The FBM Kuala Lumpur Composite Index (KLCI) Total Return Index (including dividends) has gained a meagre 1% compound annual return in the past 10 years while the FBM KLCI itself has fallen a hefty 22.1%. The returns are far worse than simply leaving your money in risk-free bank fixed deposits.
The Straits Times Index (STI )Total Return Index fared slightly better, gaining 3.7% annually over the same period. But this is still a far cry compared with the US market. The Standard & Poor’s 500 (S&P 500) Total Return Index delivered a robust compound annual return of 11.6% over the same period (see Table 1). Over such a long period, even a small percentage change in returns will make a huge difference to one’s investments. Clearly, a consistently underperforming Bursa is a big problem. A poorly performing stock market cannot attract capital — local and foreign — and investments to support the country’s economic activities.
The most obvious reasons for this huge divergence in market performances are earnings and growth prospects — the main drivers of stock prices. Earnings for S&P 500 companies have grown, and are expected to continue growing, at a much faster clip than the largest companies listed on Bursa and the SGX. Case in point: US corporate earnings expanded at a compound annual growth rate of 7.1% between 2013 and 2023, far superior to the 3.2% for STI components and only 0.7% for the FBM KLCI. Prevailing growth forecasts for Bursa also remain lacklustre.
We have written extensively on the underlying structural issue plaguing the Malaysian economy as well as the necessary reforms to arrest and reverse the downward trajectory in investments and corporate earnings. We will not repeat them here (see our recent three-part series published in this column, with articles titled “Democracy is an ideology, not a solution” [July 24, 2023], “The story of the two Souths: education, competition and corruption” [July 31] and “End ‘state capture’ to enable economic transformation and improve livelihoods” [Aug 7]).
The STI — and, indeed, the SGX — is overly dominated by a handful of mega-cap stocks, including the three largest domestic banks and real estate investment trusts (REITs). It is, therefore, not a very good proxy for the underlying Singapore economy nor reflective of its corporate sector growth.
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Using the Levy-Kalecki Profit Equation, we have shown how aggregate corporate profits have, in fact, risen steadily (see our article titled “Stating the obvious: Stock prices can only perform with sustained profit growth and positive prospects” [Oct 23]).
Stock prices — and valuations — reflect investor expectations of earnings and growth, and confidence in the company. Hence the higher valuations accorded the US market; for instance, in terms of both price-to-earnings (PE) and price-to-book values (see Table 1). The problem is, poor stock market performance becomes a vicious cycle.
There is intense competition among stock exchanges to attract the listing of quality companies with good earnings prospects. The best companies, with all the available choices, will choose a listing destination that gives them the highest (and sustainable) valuations, all else being equal. Exchanges that cannot attract quality listings, including those of homegrown companies, will continue to deliver sub-par earnings growth — and performance.
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Factors that could help enhance market attractiveness and valuations
Earnings and growth are clearly the most important drivers of stock prices. But there are secondary factors that can help boost — or, conversely, worsen — the attractiveness of stock markets, including liquidity (trade volume) and, yes, even a degree of stock price volatility. As can be seen from Table 1, the US stock market has the highest average daily traded value as a percentage of market cap whereas Bursa has the lowest ratio. This, we believe, is due in large part to its very low free float.
Free float for the FBM KLCI averaged a low 29.5%, compared with 64.7% for the STI and 94.9% for the S&P 500. Indeed, a closer look at the index component stocks shows that stocks with the lowest liquidity are, often, also those with the lowest free float of shares (see Table 2). Large percentages of their shares are either family-held or “locked up” under government-linked companies (GLCs) or government-linked investment companies (GLICs). The latter is particularly predominant on Bursa, accounting for 42.4% of shareholdings in FBM KLCI stocks — more than double the 16.5% in STI stocks. Case in point: The Employees Provident Fund’s (EPF) stock holdings as a percentage of total market cap have risen steadily over the past two decades (see Chart).
The presence of these controlling shareholders is crowding out other investors. While it does provide some stability to the market — Bursa is often seen to be “defensive”, particularly in times of extreme global market volatility — it also limits trading opportunities and the creation of useful hedging products (that will broaden the pool of investment products). Traders and certain types of funds make money by exploiting price volatility and short-term market inefficiencies as well as strategic market timing.
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A vibrant stock market is necessarily made up of different types of investors, with differing objectives and risk profiles. More market participants will, in turn, improve the flow of information and price discovery as well as liquidity and, quite likely, valuations. So, rather than fractional share trading (reduce the current board lot size) — which could lead to unintended consequences — we think Bursa and, to a lesser extent, the SGX, will benefit more from a higher free float of shares.
More than half the companies listed on Bursa (56%) and the SGX (60%) are currently trading below their book values for various reasons, one of which is the relative proliferation of investment holding companies (holdcos). Holdcos typically trade at a significant discount to their underlying intrinsic value. This is because investors see the holdings as long-term investments and, thus, have little chance of crystallising their full values. Therefore, it stands to reason that collapsing chain listings would result in better valuations and, in particular, benefit minority shareholders. In the US market, a huge majority of the listed companies are operating companies.
Proof of concept: Back in August, the Securities and Exchange Board of India (SEBI) published a consultation paper proposing an easier route for voluntary delisting of holdcos, whose shares usually trade at a 40% to 70% discount to intrinsic value. Under the proposal, shares held by the holdco in other listed companies would be transferred to its shareholders, in proportion to their shareholding.
In other words, both the controlling and minority shareholders will then own shares directly in the operating companies. This would result in higher free float and improved (and more transparent) valuations. Minority shareholders will get cash payments for other unlisted assets, based on independent valuations. The major holdcos have seen their share prices rally after the paper was made public. Although SEBI ultimately did not approve the proposed delisting regulations, it did prove that doing away with holdcos can lead to better valuations for the market as a whole. For example, shares in Tata Investment Corp have surged more than 60% since and are now trading at a premium to the value of its stakes in listed companies.
Besides holdcos, there is yet a smaller group of companies that are trading at even steeper discounts to intrinsic value — companies that trade at less than their net cash. We will explore this topic further next week.
Finally, we have also previously written that share buybacks can be a very effective way to realise the intrinsic value of listed companies — and the proof is the wide use of share buybacks in the US and how stock prices quickly react positively every time a company makes such an announcement. Sure, there is the risk that some controlling shareholders may use this as a form of stock price manipulation or sell their own overvalued shares. But if the overriding benefits are obvious, mechanisms can be put in place to arrest nefarious “bad actors”. And investors are also smart enough to distinguish between genuine share buybacks and otherwise.
The Malaysian Portfolio fell 0.4% last week, led by losing stocks, Frasers Logistics & Commercial Trust BUOU (-2.1%), DBS Group Holdings Ltd (-1.2%) and Insas Bhd (-1.1%). The two gainers in our portfolio were Mapletree Pan Asia Commercial Trust N2IU (+1.9%) and UOA Development Bhd (+1.2%). Total portfolio returns now stand at 155.8% since inception. This portfolio is outperforming the benchmark FBM KLCI, which is down 21%, by a long, long way
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
