Detailed analysis of various business sectors in Uganda

Is investing in stocks and bonds on the Uganda Securities Exchange (USE) any good?

Outside Looking In
D E Wasake Esq [With Guest Writer].

About the guest writer:

Edward Isingoma is a partner at Pearl Capital Partners an approved Investment advisor firm that is also a specialist agriculture investment firm that has been investing in small and medium sized East African agribusinesses since 2006. Edward is a member of the Institute of Certified Public Accountants of Uganda(ICPAU) and a fellow of the Association of Chartered Certified Accountants(FCCA). He holds a BSc…

About the writer:

For over 8 years I have worked with several clients in Uganda, The Bahamas and the United Kingdom in providing audit, tax, accounting and advisory services. My sector experience with clients in various sectors including financial services and investing in financial instruments such as equities and bonds enables me have good understanding of this sector. To see the full depth of my experience, Please see my profile.

Article Summary

For the passive investor, investing in stocks on the Uganda Securities Exchange (USE) is a good idea because it is still an early growth market (thus a "bull market" as prices are typically rising). On the basis of our forecasts, the profitability from investing in stocks and bonds is Shs. 12.5m per year from an initial investment of Shs. 18m. It will therefore take about 1.65 years to recover your initial investment (Return on Capital). In order to achieve this, our "advanced thinking" tips include focussing on the fastest moving stocks.

Can't get interest income from your savings?

If you are particularly a Ugandan in the diaspora or have awareness of the interest rates in markets such as the US and the UK you will for example know that the Bank of England's base rate is 0.5%. The Fed rate in the US is presently 0.25%. This is the rate that basically determines lending rates by commercial banks and thus the interest rates they pay on savings. The UK rate for example is not expected to change for say the next 3 years i.e until 2015, I expect the same for the US rate. You can therefore expect that the interest you will receive on your savings will be close to zero. I know a client of mine who at one point had £1m but were still receiving no interest!

The search therefore for investments paying a "reasonable" return is never ending in these challenging times. One option therefore is to consider investing in stocks and bonds in the Uganda Securities Market(USE).

First the basics of what stocks and bonds are and how the stock market works.
Stocks (using an example)

Stocks also called shares or equities are a "slice" of the share capital of a company that are offered to the public. If therefore a company has say UGX 1m in share capital and each share is say worth UGX 1(nominal price), there are therefore 1 million shares. The company can then choose to say offer 20% of these shares to the public. It in other words offers 200,000 shares to the public. It however does not offer them at the nominal price but issues them at UGX 2 each (thus at a premium).

As an investor, you could therefore buy say the whole 20% of the shares ie (200,000 shares) at Shs 400,000 (UGX 2 x 200,000). You can subsequently choose to sell these shares say at UGX 4 each hence at Shs 800,000 and making a profit of UGX 400,000. The sale and purchase of shares is really how the stock exchange works, it connects buyers and sellers of the public company's equities.

Bonds (using an example)

Just like shares are a means of a company raising financing(as usually the shares are issued at a premium) as in the above example, bonds are also another means of a company(or say government) raising finance. The difference is that a share gives you part ownership in the company whereas a bond is similar to an IOU in otherwords the issuer of the bond(say the company) promises to pay you on a future date(say 3 years) the principal amount of the bond (the "loan you give it) plus interest.

A “3 year 10.25% Treasury bond of UGX 1m” therefore means that that the issuer of the bond(in this case the Government of Uganda(GOU) will in 3 years pay you back the principal of Shs. 1M plus interest of 10.25% . The interest is usually paid semi-annually.

Just like shares, bonds can be traded on a stock market. In other words an institution such as National Social Security Fund (NSSF) will buy bonds during an auction but say in the unlikely circumstance that they do not wish to hold the bonds for the maturity period i.e. the 3 years, they can choose to sell their bonds on the stock market. The person purchasing the bonds will often buy them at a premium or discount (dependant on the market interest rates). If the investor purchases the bond at a discount, it means the investor pays less than the face value of the bond and will enjoy the interest on the bond for the rest of the maturity period plus the discount on purchase of the bond.

But what about investing in shares and bonds on the USE?
USE and its "bull market" phase

The USE has only been in existence since June 1997 and therefore is now in its 15th year. It is still very much an emerging market as of course when compared to markets such as the New York Stock Exchange (NYSE) which was formed in 1792, the London Stock Exchange(LSE) which was founded in 1801 and the Tokyo Stock Excange (TSE) in 1878.

Our recent founding of the bourse however works to our advantage. Emerging markets' stock exchanges often have significant increase/growth in the early years as they develop and as such are typically “bull markets” (a market where prices are rising or expected to rise). The statistics for the growth of USE's All Share Index (ALSI); a measure of all the companies listed on the exchange for example shows that the share price has generally been rising except for 2008 the peak of the credit crisis.

Table 1: USE All Share Index ( ALSI) growth.
YEAR LSI Price % Movement














The bond market is also experiencing increased growth and per the 2010 USE annual report the activity increased 4%.

The above seems promising so is it worth investing in stocks and bonds via USE?

FIRST THE CONS (of course)
1. “Low Liquidity owing to low volume of trading

Despite the increasing activity on the USE, as we are still an emerging market, the volume of trading is pretty low and some shares on the basis of the trading statistics in fact have no activity for a day or couple of days.

From my analysis of the Mar 11 to March 12 trading activity, I for example note that there were 14 equities traded with a total number of 4,105 deals. Of these deals, Stanbic Bank (SBU) shares alone contributed 46% of all deals. Uganda Clays (UCL) then contributed another 16% of all deals and Bank of Baroda (BOBU) another 10%. The 3 companies alone therefore contributed over 70% of the Exchange's activities.

This means to consider investment in this, especially for profit purposes, the focus should most likely be on these 3 shares which have the highest trading volumes as you can expect these will be most representative of an active market in which you can buy or choose as you desire without time delays in finding a seller or buyer. My model/analysis later on therefore focusses on such shares.

2. Foreign Exchange losses

A key consideration in investing in the USE, especially if a Ugandan in the diaspora, is to give consideration to the exchange rate movements. The shilling has over the last 5 years been depreciating against the GBP and the USD and therefore if you are investing say in a 3 year bond then you need to consider how the exchange rate depreciation might move and thus affect the value of your investment as I show below.

Table 2: Average Forex rates GBP/UGX for 2007-2012 (March to March)
YEAR(mar-Mar) GBP/UGX ROE % Movement Average
2012 3863.31> 1.95%  
2011 3789.56 23.22%  
2010 3075.4 11.08%  
2009 2768.64 -18.13%  
2008 3381.66 1.24% 3.87%
2007 3340.36

Table 3: Showing how the Forex depreciation (table 2) can affect an investment
Investment amount GBP Ex. rate IN UGX
At start(12 March 2012) 10,000 3,863.31 38,633,100
2013 9,627.3 4,012.87 38,633,100
2014 9,268.5 4,168.22 38,633,100
2015 8,923.06 4,329.58 38,633,100
Loss of investment value 1,076.94   38,633,100

The loss over the 3 years of £1,076.94 is determined as follows:

1. At inception, the original investment is in GBP i.e. £10,000. It is then invested in a Uganda shilling bond and the worth then is Shs 38,633,100.

2. As the bond is Uganda shilling based, its value in Shs does not change.

3. The value of the equivalent Shs 38,633,100 when re translated back to GBP each year however records a loss as a result of the exchange rate movement in this case assumed to be 3.87% per year on the basis of the overall movement in the 5 years from 2007 to 2012

3. Interest rates significantly lower than inflation rates

If considering for example investing in bonds, then the interest rates offered on bonds are often typically significantly lower than the inflation. The headline inflation in February 2012 was for example 25.4% and yet the latest bond auction on 6 January 2011 offered a 3 year bond at an interest rate of 10.25%.

If you are therefore expecting to rely on the interest income from bonds then this is something to factor in especially when compared to other investments. It is of course difficult in the current Ugandan environment to find investments returning a real rate of return in excess of the inflation rate.

4. Broker commissions

While for many of the more advanced stock brokers have moved from percentage based commissions to fixed charge commissions while in Uganda the USE remains on a % based commission. USE brokers charge 2.1% on the first Shs. 200M of each trade. Compare this to leading broker Charles Swabb who charge a fixed fee of $34 for a broker assisted commission. A Shs. 200M sale would therefore generate this fee with Charles Swabb whereas USE would charge 2.1% of this amount i.e. Shs. 4,000,000 or $1,609.98 at the 12 March 2012 exchange rate!

Broker commissions based on price are therefore a disadvantage where the amount per trade is larger and of course the converse is true, that is, it is more advantageous to use a commission % compared to a fixed rate if the trade deal size is small, as I suspect is the case for the bulk of Uganda's deals.

5. Bond rating

Many a foreign investor will consider the crediting rating of Uganda as part of their consideration of investment in say Uganda Government Bonds. Standards & Poor’s (S&P) for example at February 2012 ranks Uganda as BB- This rating indicates that in the short term there is stability of the country but long term uncertainties remain. As regards to investments, it indicates that there is some default risk. S&P clearly highlights that these ratings only cover one aspect of investments default risk. The Government of Uganda has to date not defaulted on any of its bonds but of course on the basis of the S&P rating, this should be given some consideration.

1. Good returns for stocks owing to bull market tendencies

In light of the CONS highlighted, the clear advantage therefore for the investor who has access to other stock exchanges but who want invest in the USE is to consider investing in holding stocks in the short term i.e say a year before selling them as with a bull market as is the case with USE, it is expected that share prices will rise. The investor can therefore purchase shares and sell them. The growth of shares will hopefully offset the exchange losses and broker commissions. I show the expected return in my model shown later on. It is interesting to note that one of the companies that continues to have significant trading volumes is Uganda clays despite not paying shareholders dividends for 3 years and posting losses of over 3bn. This only further serves to higlight the interesting aspects of the stock market in Uganda or perhaps of any stock market.

2. No capital gains tax

One of the key advantages is that per USE website, there is no capital gains tax (CGT) chargeable. Capital gains are the profit made when you sell shares at a higher price than you bought them. The investor can therefore enjoy their profit tax free. It is not uncommon to pay CGT in more developed economies.

3. Dividends prospects

Whilst I advocate for short term holding, it should not be ignored that the nature of companies with shares listed on the USE are typically dividend paying companies owing to the underlying sectors on which they focus. I have in my model also analysed the dividend prospects for the investor i.e if he was holding the shares for purposes of dividends but on the basis of the analysis, the results are dire. Uganda clays for example whilst having the second most traded shares has not paid dividends in 3 years! Bank of of Baroda on the other hand paid a dividend in 2010 of only Shs 3 per share. In my model, at this dividend per share rate, the investor will realise their investment in 60 years!

On the basis of the Pros above, I therefore summarise the financial model below.

Table 4: Financial model showing returns on equities, bonds and dividends on USE

Analysis of return on capital for investment in equities, bonds and dividends

P.S Clicking the above link will take you to the Inachee Databank where the full version of this document can be dowloaded after you register.

My Guest Writer weighs in

"It is worth noting that opening a trading account with USE will soon allow one to participate directly in both bond and equity investments.

It is certainly important that this article raises interest in alternative investments about which many Ugandans simply have no education and yet the opportunity is massive. Stock and bonds should be part of any investment portfolio, primarily from the fact that they are not pegged to high capital requirements to initiate. This is very important from a participation point of view.

I will quickly just move on to high level comments around the article. I think it focused a lot on returns per se to build a case for bond or stock investments without explaining what drives returns. A stock investment represents an interest in a company’s business operations, and thus for any equity investment to generate returns one must understand the growth prospects of a business into the future. Businesses do not grow overnight, and thus one cannot expect equity prices to improve overnight. By their very nature stock investments must be long term and value must align with the prospects of the underlying business. I advance holding periods of 5-7 years, with re-investment of dividends in great businesses, for a valuable portfolio of equities to be created.

Bonds in Uganda are primarily dominated by government paper. In rare time of stress, such as 2011, they represented very important investment opportunities, offering returns as high as 28%. Depending on the general interest rate environment one can shift between long term and short term bonds, moving to the short end when rates rise, and moving to the long end when short term rates are expected to fall or as they fall. There is of course a lot of analytical debate here, but this is the basic principal. One can also participate in the more lucrative corporate bonds, whose returns benchmark on the ‘risk free rate’ in the market-loosely quoted as the government rate on a relevant term of paper."

First the numbers:
  • Start-up Capital (A): Shs. 18,931,650
  • Profit per year (B): 12, 586,182
  • Other costs (C)-broker fees and FX losses: Shs 1,145,357
  • Return on Investment/Capital (years to get capital back) (A/(B-C)): 1.65 years

On the basis of my model analysis, the clear winner is equities which are held by the investor on a short term basis say 1 year and then sold. The other two i.e. bonds and dividends are in table 4 for comparison purposes. Their returns are 3 years and up to 60 years respectively. The summary below is therefore presented for only equities.

Return on Capital for Equities
Now the basics you must get right before investing.
  • Act through a broker. As the clear winner is considering equity investments for a short while, it is most likely necessary to have an investment broker who will provide you with regular reports and guidelines so you can implement your buy and sell strategy. Capital Markets Authority (CMA) the regulator for USE has a list of brokers, fund managers and investment advisors.
  • Research. If you choose not to use a broker, then the least you can do is research extensively on information such as prices and qualitative information on your target. The financial statements and press reports/stories give you an indicator of the nature of the entity. There is of course a limit to this research; past performance does not equal to future performance. Your broker/advisor can most likely help you in this aspect as well.

Whilst you may not be a pro at the open cry auction system that USE uses and considering you might not be interested in the intricate details of how stock markets work, there is definitely a lot of merit in investing in the USE considering that despite the CONS such as FX movements, there can be returns in just over 1 year which can be significantly better than investment say in fixed savings in the UK or US.

My guest writer however astutely observes that rather than holding equities for a short term as I propose, it is worth considering holding shares for a longer term period. He also draws attention to the "lucrative" corporate bonds that I recommend any of the "advanced thinking" investors should consider.

Otherwise best of luck and of course if you need some help, do not hesitate to speak to us to get the ball rolling, Inachee afterall represents Home Grown Energy in Motion.

Otherwise, best of luck and of course if you need some help, do not hesitate to speak to us to get the ball rolling, Inachee after all represents Home Grown Energy in Motion.

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And now the disclaimer:While I have taken steps to research this information as well as based on my experience, you should not solely rely on the information given here to base your investment decisions. You should seek business advice from a professional knowledgeable of your specific circumstances. I shall therefore not be held responsible for any loss you may incur when acting on this information.



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