As Nigerian investors face a third successive year of Treasury-Bill rates well below the rate of inflation, Coronation Research conducted a five years analysis to unravel the Nigerian investments that beat inflation over the long term, the result of the survey showed equities was the answer.
Coronation Research studied equity returns during the period from 1 January 2016 to September 30 2021. While the performance of the NGX All-Share Index was not strong, the performance of a selection of the most profitable NGX-listed companies provided superior and inflation-beating returns.
The report titled ‘Equities for Superior Return’ revealed that the return of the NGX All-Share Index in the review period was 40.50 percent or a compound annual growth rate (CAGR) of 6.15 percent. With gross dividends reinvested, that rose to a CAGR of 12.44 percent. But neither return would have beaten inflation over the same period, which averaged 14.26 percent per annum.
However, a basket of 10 NGX-listed companies, each with a long-term and sustainable Return on Equity (RoE) of 20.5 percent or more, would deliver an investment return with a CAGR of 16.36 percent from 1 January 2016 to 30 September 2021. With dividends reinvested, this would have risen to a compound annual growth rate of 24.71 percent, research analysts at Coronation said.
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“This basket would have easily beaten inflation of 14.26%, giving a compound annual growth rate, in inflation-adjusted terms, of 8.29%. And in US dollar-equivalent terms, the compound annual growth rate would have been 9.71%,” the report said, adding that “It is simply a case of finding the right stocks with sufficiently high and sufficiently sustainable RoE.”
For many investors, the equity market remains a speculative arena with high volatility (the NGX All-Share Index rose 50.0% in 2020) and risk. Coronation research through its new report set out to prove an alternative point of view, namely that listed companies with high and sustainable profitability (it choose Return on Equity, RoE, as its benchmark) provide superior investment returns over the long term. It selected 10 NGX Exchange-listed stocks, created a hypothetical ‘High RoE Portfolio’ and back-tested it from 1 January 2016.
In the report, Coronation Research imagines a prosperous Nigerian household that, in January 2016, had one million Naira in savings to invest. Then, it followed what would have happened to their money if they had invested in either equities or Nigerian Treasury Bills (T-bills).
Considering a theoretical and prosperous Nigerian household consisting of Mr and Mrs Olufemi. Coronation imagines that at the end of 2015, the family had household savings to the tune of N1,000,000 (US$5,022.60 at an exchange rate of N199/US$1 at the time). Accordingly, they agreed to invest in the equities market, starting on 1 January 2016, benchmarking the NGX All-Share Index.
Using the NGX All-Share-Index (ASI) as the benchmark, over a five year and nine-month period ending 30 September 2021, Coronation said the investment would have earned, in nominal terms, 40.50% making N405,024.04 (CAGR: +6.15%).
“However, the investment would have earned -37.16% in inflation-adjusted terms, losing N371,598.19 (a negative CAGR of 7.83%). Note that for almost half of this period, the nominal return – i.e., before calculating the effects of inflation – would have been negative; the value of their holdings would have been less than their initial investment,” the research analysts said, adding that volatility of this nature often leads investors to lose faith in equities, and, in all likelihood, the family would have maybe sold their equity investment at some point when the return was in negative territory or perhaps cashed out when they could realise a small nominal gain.
Thus, “holding equities for an extended period is not for the faint-hearted.”
Looking at inflation-adjusted returns is important because an investment in Naira needed to return at least 15.0 percent per annum just to have overcome the effects of inflation over the past six years. Only with consistent investment returns of 15.0 percent-plus do we begin to see positive inflation-adjusted returns. While risk-free investments, such as Nigerian Treasury Bills and government bonds, provided this in the past, this has not been the case for the last two years.
For many years Nigerian investors did not have to take risks to beat inflation. They earned yields on risk-free T-bills that were comfortably higher than inflation. From 2010 to late 2019, for example, it was possible to hold a risk-free T-bill and earn, on average, 2.67 percentage points more than the rate of inflation.
All this changed in late 2019 when T-bill rates crashed. They went on crashing throughout 2020 when 1-year T-bill rates fell from 5.40 percent pa in January to 0.15 percent per annum in early December. In 2021 they have risen again, but only to around 7.50 percent pa, well short of inflation at 15.99 percent year-on-year.
As important as beating inflation, Coronation said Nigerian investors want to earn a positive return in U.S. dollar terms. A compound annual growth rate of 24.7 percent in Naira over nearly six years does that, Coronation Research said.
“Taking the interbank exchange rates as our yardstick, our High RoE Portfolio, with dividends reinvested, achieved a compound annual growth rate (CAGR) of 9.7% in U.S. dollar terms over the study period 1 January 2016 to 30 September 2021, a cumulative return of 69.9%.”
For a truly superior return, Coronation Research said investors need to identify listed companies whose internal Return on Equity is high – it stipulated a minimum of 20.5 percent per annum.
“Furthermore, this return on equity needs to be sustainable. We found 10 NGX-listed stocks with these characteristics and created a hypothetical portfolio with these stocks in equal weight. Then we measured their total returns from 1 January 2016 onwards and came up with the surprising results given above,” it said.
Coronation Research is a division of Coronation Asset Management that offers full-fledged investment services across various asset classes to the entire spectrum of investors.
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