We all want to join the billionaire’s club. To hammer. We have seen Mark Zuckerberg hammer through his technology firm and Aliko Dangote through more traditional ventures, but what about through the stock market?
A quick look at Forbes' Africa’s Billionaire List shows that none of them made their wealth from investing in stock markets. In comparison, a scan of the Forbes’ World’s Billionaires List shows over 40 US billionaires made their fortune by investing in the stock markets through hedge funds. And this discrepancy exists even after accounting for the fact that there are more billionaires in the US. So the outstanding question is simple - have Nigerians overlooked the opportunity to hammer through the Nigerian Stock Exchange?
Before we answer this, first some caveats. Investing in the stock market requires money, patience, and discipline. Money because “money begets money”. Patience and diligence because investing is often a waiting game punctuated by unpredictability and volatility. You could find yourself holding a stock like Forte Oil – quadrupling in value between 2014 and 2016 before shedding nearly half of that value by the end of 2016.
The Compounding Effect
Now to the big secret to joining the billionaire club: compounding. The compounding effect, or in Einstein's words, the eighth wonder of the world, is the ability of an asset to generate earnings which are automatically reinvested to generate its own earnings. The returns from compounding an investment grow exponentially large over time. Take the Mona Lisa painting, for example; valued at almost $1.5 billion. But if King Francis invested the initial $20,000 used to commission the painting in 1516 at an annual interest rate of 6%, he would be able to buy the painting a million times over – as would you if you had $1 quadrillion sitting in the bank.
Monish Pabrai, an Indian-American businessman and investor who has adopted cloning the investments of other super-investors like Warren Buffett and Charlie Munger to beat the average market returns, capitalised on the compounding effect with a “30-year game plan” to become a billionaire by his 60’s. According to Pabrai’s 30-year game plan, if you can make a 26% return each year and reinvested that sum immediately, then your investment would double roughly every three years, and in 30 years your investment would have multiplied by 1,000. The math works out when you use a compounding calculator.
Practically, an initial ₦1 million investment with a 26% compounded annual return would be worth ₦1 billion in thirty years. In nominal terms, at least.
Maintaining Superior Returns
Investing in the stock market does not come without heartache. Achieving the 26% annualised return for 30 years is fairly uncommon. According to the HFR database, hedge funds delivered an average return of 5.6% in 2016, falling short of the 11% gain in the S&P 500 last year, emphasising how difficult it is to consistently achieve superior returns.
To see the possibility of matching this feat in Nigeria, I considered either investing in equities or relying on bank interest rates. We can discount the latter as the last time returns on savings came close to matching the 26% mark was in 1993 when deposit rates were 23%. They have trended downwards since then with an average of 12%, meaning a ₦1 million investment would be worth nearly ₦32 million today in nominal terms. But we know there has been high inflation and significant currency depreciation in this period, so your investment would be worth much less than that in real terms.
Now, equities. Most hedge funds attempt to beat the average market return by employing different types of investment strategies. One report by Lazard shows that over a period, a strategy of buying undervalued stocks and selling overvalued stocks (a long/short strategy), more often than not, beats other investment strategies. This still requires the skill of knowing what to buy or sell and when to buy or sell it, and Warren Buffet’s business acumen or George Soros’ economic foresight does not come easily. So instead of trying to beat the market, could you follow the trend by investing in the index? Over a 19-year period from 1998 to 2017, the Nigerian Stock Exchange All-Share Index (an index of all shares trading on the exchange) had a compounded annual growth rate of 8.7%, still far below 26% mark required for the 30-year game plan. It would take a lifetime (83 years) to become a billionaire using this approach.
How to Make a Billion?
Our simple analysis bore little fruit – based on previous trends, you are unlikely to hammer through investments. This answer should not surprise us. Investing is just another way of making money, and like a business or mastering a skill, it is equally hard, if not harder, and there is no guarantee of success.
The decade between 1998 and 2008 offers some hope. ₦1 million invested tracking the NSE ASI at the start would have compounded at an annual rate of 28.5%, exceeding the 26% benchmark and returning you over ₦15 million. Granted, it may become harder to maintain this performance (the ASI did not and has performed particularly poorly recently) but with some foresight and luck, who knows? You could just hammer. In 30 years, of course.
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