by elmads

Introduction

I started investing when I was 23 years old—this was back in 2013, and it was all thanks to my dad. He encouraged me to start as soon as possible, which I did, but not immediately, a lot of things happened before I followed his advice.

I chose Col Financial Philippines as my first broker account, which I’m still using to this day. Why did I choose Col Financial? Back then, it was the investment account my parents and relatives used, and I haven’t changed investment brokers since then.

So, the next step is learning how to navigate the web interface of Col Financial, transfer money, and eventually where to invest.

I’ve shared the details about this in my blog titled “Don’t Invest directly in Stocks as a Beginner, Only If. . .”

I was happy as I initially followed my dad’s and uncles’ advice on where to invest my hard-earned money, but things eventually changed when curiosity got the best of me again.

“The important thing is not to stop questioning. Curiosity has its own reason for existing.”

– Albert Einstein

Brother Bo Sanchez’s The Truly Rich Club

From 2013 to 2019, I only followed my dad and uncle’s initial investment advice. Take note; I still don’t have any idea what I was doing. I just trusted what they’d told me without even exerting the time and effort to understand the basic things about the nuances of equity and stock investing.

The investment advice I followed before was this:

• Invest in companies that provide the basic necessities of the people, e.g., electricity, water, internet, etc.
• Invest in companies where you and most people that you have observed, regularly buy their products and services.
• The more people spend, the more money a company will generate, and the less likely it is to go bankrupt.

The advice seems sound and practical if you think about it, but these things are too general, a lot of factors can derail our company’s investments. I didn’t know about the risks of just following that general advice yet, and I even didn’t care at all.

Then, in 2019, I encountered Brother Bo Sanchez’s Truly Rich Club. Basically, it is a group that, once you’ve subscribed to their services, you’ll be able to get access to their stock investment advice, ideas, and recommendations. To be a group member, you must pay a subscription fee.

Someone asked me to join the said group so that I would know what to buy, hold, and sell, and this person told me that the group has been very helpful with his investments. I told him that, as much as I would like to join, I don’t have the financial resources to do so, as the amount of money required to join was a significant amount relative to my monthly salary. I told this person that instead of paying that money for a subscription, I’d just invest it and continue what I had been doing back then.

Subsequently, after a few months, a relative of mine who was a member of the Truly Rich Club sent the group’s Strategic Averaging Method (SAM) table for August 2019 and another one for September 2019.

I don’t know much about how things work with the Truly Rich Club’s investment recommendations, but as you can see in the photograph above, they have suggestions for every stock.

Let’s use the August 2, 2019, SAM table chart and the Aboitiz Power column.

NOTE: Aboitiz Power Corp. is an investment holding company that engages in the provision of power generation and distribution in the Philippines. It operates through the following segments: Power Generation, Power Distribution, and Parent Company

(From left to right),

• The company stock ticker symbol: AP for Aboitiz Power
• The current price as of August 02, 2019, closing date, was 34.80 PHP per share.
• Buy below the price of 36 PHP per share. This means that you could continue to buy more AP shares if they are below 36 PHP per share.
• Target Price: 48 PHP/Share Once the stock price of AP reaches 48, the recommendation is to sell.
• Recommendation: Continue buying. As the name implies, continue to purchase AP stock because the current stock price was 34.80 PHP/share as of August 02, 2019 closing, which was below their buy below price recommendation of 36 PHP/share.

It’s a straightforward table that everyone would be able to understand. It seems that everything will be okay as long as we follow TLC’s SAM table recommendations. I told myself that maybe I need to start subscribing now to Truly Rich Club (TLC) to maximise this opportunity.

Yet, a lot of questions came into my mind after I saw these tables. Questions such as:

1. How are they able to get the buy below price and the target price?
2. What are the chances that the stock price of the company will reach its target price?
3. What if it doesn’t work? What if the stock price goes down rather than up?
4. What if the companies go into bankruptcy? What will happen to my hard-earned money?
5. There are a lot of companies in the Philippines, why are they not included in the list?
6. What are the risk and reward in following their recommendations?

There were a lot of questions in my mind, and I got very curious to find these answers. So, I dug deeper, which got me completely sucked into the world of investing. This started my investment world learning journey.

“Master the fundamentals, and the rest will follow.”

Jack Nicklaus

As individuals, where do we get money to purchase goods and services?

Where do we actually get money to spend for our wants and needs?

Commonly, it is via our accumulated savings from our salary via active income, debt or by doing both.

• Accumulated savings from our salary. Employment is usually everyone’s starting point to be able to generate income, and through it, they’re able to purchase goods and services for their own lives.
  
  The downside to saving money is that it takes time before we are able to save enough, and the more expensive the item or service we want to purchase, the more time we need to save in order to be able to buy it. For instance, if we want to purchase a car worth £15,000 and our net monthly salary is £1,900, how long would it take for us to be able to generate that £15,000? considering our lifestyle expenses and the amount of money we save for the car per month. It might take months, if not years, for us to be able to purchase the specific car we want by just saving money.

• Debt. This is the fastest way to get money. It involves borrowing money from somebody else, such as banks, government entities, employers, friends, relatives, or small businesses.
  
  It is an agreement where we borrow a certain amount of money in exchange for paying interest on the borrowed amount. Interest serves as a reward for the lender for allowing someone to use their money and acts as a form of risk management.
  
  The problem with borrowing money lies in the interest rate and the payments that the borrower needs to make. Taking on debt is essentially borrowing money from your future self, as eventually you will need to repay the same amount along with interest.

• Taking on both accumulated savings and debt is a no-brainer decision, especially when purchasing your first home. For most people, saving more than £150,000 within a year to 5 years, or even within 10 years or more, is not feasible. It is essential to consider the family’s earning power, lifestyle expenses, and life priorities.

These are the three common ways to raise capital on an individual level.

Now, if that’s with individuals, how about with small businesses? How do they raise capital for expansion and growth?

How about for small and medium businesses? How do they raise capital for expansion and growth?

It is almost the same with individuals. It through the accumulated savings through the business’ cash flow and taking on debt. But there’s an additional approach which is not applicable with individuals, and that’s equity financing.

We must first define what is an equity of a business.

It is the amount of money which represents the shareholder’s ownership in the company. It is shown as the word “Equity” in a company’s balance sheet. It is computed by subtracting the total assets of the company to its liabilities.

Let’s use Microsoft corporation’s 2023 balance sheet as an example.

Its total assets are worth $364.84 billion, while its total liabilities are worth $198.30 billion.

• Equity = Total Assets – Total liabilities
• Microsoft’s 2023 Equity = $364.84 billion – $198.30 billion
• Microsoft’s 2023 Equity = $166.54 billion. This is the amount of money that all shareholders of Microsoft corporation own.

Now we go to equity financing. This means that we raise capital by giving out shares of our business to a potential investor. Thus, the investor becomes an owner of the business.

It is different from taking on debt because the person giving us the money (the lender) doesn’t become a part owner of the business.

I’ll give you a scenario to make this more understandable.

Equity Financing, A Scenario.

We have Nico, who has his own small tea shop in his local town. The business has been booming for a couple of years now, and people from other towns visit his one and only store. The demand ballooned that he finds it hard to keep up with it anymore. His business has good income flow, and he eventually decided to open additional stores in other towns.

After a few years, an opportunity arises where there is commercial space available in one of the busiest cities in the country. He analysed the potential earnings that his business could generate if he were able to get the said commercial spot. He calculated the potential costs, working capital required, additional capex, and others. He calculated that he would need approximately £100,000, but his business only has £60,000 in cash and cash equivalents.

He was able to raise additional cash via a bank loan worth £20,000. That’s already the maximum amount he can borrow. He doesn’t want to exhaust all his cash, so he decided to leave £10,000 as a cash reserve and then spend the remaining £50,000 on expansion. His total amount of money would then be worth £70,000 (£50,000 in business’ cash plus £20,000 in debt).

Nico would still be short of £30,000, as he only has £70,000. Where would he then get that extra money? Recall that the maximum he could borrow was £20,000 with his own bank, while other banks declined his loan request.

Nico decided that he was willing to partner with someone. He said that “this potential partner shouldn’t just be able to add £30,000 to the business but also have the experience and expertise to add something to the table to further grow and expand it”

Nico found that potential investor in a friend of his who has experience handling public and government finance and knows the nuances of investing and personal finance. He personally weighed his options and decided that his friend was the perfect person to partner with. Nico pitched the business to his friend, whom we’ll call Carlos.

Nico has been prepared for this; he even made a proper presentation of his business. It relayed almost everything, from when it started, its vision and mission, the revenue streams and their breakdown, the product costs, the operation, logistics, marketing, its payments on its debts, the net income, the projections, the plans for expansion, historical financial records, financial ratios, and others.

Carlos is amazed by Nico’s preparedness. Nico offered to take £30,000 worth of his money in exchange for 20% equity in the business. He said to Nico that he would first review his presentation and the papers that he had made.

After a few days, Carlos eventually agreed to partner with Nico. He gave him £30,000 worth of his money and now owns 20% of Nico’s tea business. Nico now only owns 80% of the business, which was previously 100% before he took the equity financing route to raise capital.

NOTE: The transaction and deal sometimes vary; there are business partnerships where other owners are just silent partners and don’t try to take part in the operations, finances, and decisions of the business, while there are others where they are actively participating in the day-to-day decision-making of the business.

What are the pros and cons of becoming a shareholder in a small business? As the business grows over time, including its earnings, cash flow, and equity, so does the amount of money you own in its equity. On the downside, if the business fails, so does the money invested in it.

Going back to the scenario above

Nico owns 80% of the tea business, while Carlos has 20%.

Let’s say in year 1, the total equity of their tea business is worth £50,000. Nico owns £40,000, while Carlos owns £10,000 in terms of equity in the business.

Then, in year 10, the equity of the business grew to £300,000. Therefore, Nico now owns £240,000 of the equity of the business, compared to £60,000 for Carlos.

Then we add the potential dividends that they can pay themselves, the owner of the business. As the free cash flow increases over time, so do the dividends they can pay themselves.

All in all, if both Nico and Carlos continue to grow their businesses, then the potential profits will keep growing.

I’ve discussed this more in my blogs titled “Raising Capital, A Story” and “A Simple Market Narrative”.

Dragon’s Den, A True Story.

Are you familiar with the TV shows above? Shark Tank (left) is an American show, while Dragon’s Den (right) is a British show.

It is like X-Factor or America’s Got Talent, where there is a person standing in front of five judges, but instead of showing his/her personal talents, the person will be pitching his/her own business to get funding and support from the judges.

“Budding entrepreneurs get three minutes to pitch their business ideas to five multi-millionaires who are willing to invest their own cash, time, and expertise to kick-start the business. After the pitch, the Dragons have the opportunity to ask questions about the venture. The entrepreneurs don’t always have to answer, but of course, what they choose not to address could very well affect the outcome. The pitch is over when each of the Dragons has declared, “I’m out”, or when they secure the full investment that they are asking for.” -IMDb

I don’t watch the programme live but I do watch the top pitches of the week or month via YouTube. It’s more like gaining additional insights about funding and small business in general.

So far, I have one favourite pitch in Dragon’s Den UK. It was a very smooth and well-thought-out pitch. The CEO certainly knows everything about his business and the industry. This is the Gener8 business of CEO Sam Jones.

Opening statement from CEO Sam Jones’ pitch.

“The open secret within the advertising industry is that it is built on exploiting our data. Like when you mention something to your friend, the next thing you know you’re being bombarded with ads for it. Everything we do online is being tracked to follow our movements and understand our behaviour. They collect this information and sell it. But I believe people should have a choice to stop this from happening, or even better, to earn from it themselves.”

Enter their Gener8 business model. 

Gener8 is a browser like Google Chrome and Bing, where once you download it and use it for searches, you’ll have two choices about what to do with your data: privacy or rewards.

Privacy: as the name implies, the Gener8 web browser will block all tracking and harvesting of your data.

Whereas, if you choose rewards, the browser will ask for your interest. This is where they will base the ads that they’ll be showing you in your searches while using their browser. In return, they give 80% of their revenue back to their users, and then they get the remaining 20%. The 80% given back to the user is through what they call gener8 points. You can use these points to redeem products, vouchers, or donations to charity.

As with any internet web browser business model, they also get money from paid advertisements from businesses, which they’ll show to their web browser users depending on their personal interests.

Since I saw this pitch, I immediately downloaded the Gener8 web browser and have used it since then. I mostly use the points to get Amazon vouchers, which I then use to get discounts for my LEGO investments. 😂 #LEGOinvesting “Are LEGO sets an investment?”, “LEGO Investing”, “LEGO Investment Metrics”.

After the end of Sam Jones’ pitch, all five of the Dragons (this is what they call the judges and investors of the Dragon’s Den show) were impressed with his pitch and business. Four of them offered what he asked for: £60,000 for 10% equity in the business, while one declined just because her expertise is not in the technology industry.

Sam was exhilarated and grateful for this opportunity, and he didn’t just get a great deal but a wonderful deal. He asked two Dragons, Peter Jones, who has technology experience, and Touker Suleyman, known for his retail and manufacturing industry expertise, to partner with him, giving each 5% of the equity of his business. In return, they’ll be investing £30,000 each.

And he was able to get the deal.

Below is the YouTube link to Sam Jones outstanding business pitch.

If you’ve watched the video above, you might have noticed that money/capital is not the only important factor when finding an investor and a partner for your business, because the knowledge, skills, and connection of your partner are also integral factors that could bring your business to a higher level. As like what Sam Jones did, he chose two dragons because of their resources and expertise in their field that is related to his Gener8 business. 

Taking Gener8 as an example. What if . . .

So, let’s just say that gener8 has reached a market valuation of $1 billion and has a substantial market share in the UK. Then the management and owners decided that it was time to expand to the international stage to capture further market share. Every expansion and growth will always require additional resources such as land, labour, enterprise, and capital.

Larger businesses can get capital from their own businesses’ cash flow, saved capital, debt financing, and equity financing, just as small to medium businesses can.

That being said, there’s just this one problem with equity financing for larger companies, and that’s the capital they usually need to raise.

Larger companies usually need money that is in the millions to billions, and finding a single person to give them that kind of money is impossible. Even if there are few individuals in this world who’ll be able to give that amount of money, let’s say 20 people, they would not easily invest that amount of money in a company unless they find the reward outweighs the risk. That amount of money would usually come from larger investment companies and also from a thousand to a hundred thousand individual retail investors.

Thus, the path to raising capital that requires a monumental amount of money is usually done through the initial public offering, or, in short, the private company becomes a public company where several people would be shareholders of the company. Here now enters the stock market and why investors call the stocks and shares they hold as ownership of a business and also call themselves shareholders of a public company.

IPO is an equity financing through the route of the Capital Markets.

The Capital Markets

The term capital market refers to a financial market where individuals, companies, and governments can raise long-term funds by buying and selling various financial instruments. It is a platform where entities can engage in the buying and selling of securities such as stocks, bonds, and derivatives.

The capital market plays a vital role in facilitating the flow of capital from those who have surplus funds (investors) to those who need capital for investment and expansion (issuers). It provides a mechanism for businesses and governments to raise funds for various purposes, such as financing new projects, expanding operations, or managing debt.

In the capital market, securities are traded either on the primary or secondary markets. The primary market is where new securities are issued and sold for the first time through initial public offerings (IPOs) or bond offerings. The secondary market, on the other hand, is where previously issued securities are bought and sold among investors. Examples of secondary markets include stock exchanges like the New York Stock Exchange (NYSE) or the London Stock Exchange (LSE).

The capital market serves as a crucial avenue for investors to allocate their savings and earn returns on their investments. It also provides opportunities for businesses to access capital to fuel growth and economic development. The performance and activities in the capital market are influenced by various factors such as economic conditions, investor sentiment, regulatory frameworks, and market dynamics.

To know more about the stock market and the bond market, see the blog links provided below.

• How Shares are made and how the Stock Market works
• Stocks and Shares
• Bonds Asset Class
• Valuing Bonds
• Bond Laddering Strategy

Initial Public Offering (IPO)

There is this notion that IPOs are equity financing for the big boys, the large companies, but that is not always the case. Small, highly valued companies can also undergo an IPO. Once a private company becomes public, it’ll be categorised based on its market capitalization.

• Mega Capitalization Companies – Market cap of $200 billion and greater, e.g., Apple Inc.
• Large Capitalization Companies – $10 billion up to $200 billion, e.g., Nike.
• Medium Capitalization Companies – $2 billion to $10 billion, e.g., Greggs PLC.
• Small Capitalization Companies – $250 million to $2 billion, e.g., Focusrite.
• Micro Capitalization Companies – $50 million to $250 million, e.g., Cake Box Holdings.
• Nano Capitalization Companies – Under $50 million , e.g., Virco Mfg.

When a private company transitions into a public company by offering its shares to the public and listing them on a stock exchange, its responsibilities expand. The company now has obligations towards its shareholders, who are now external investors and owners of the company. It must prioritize their interests and work towards maximizing shareholder value.

Additionally, as a public company, it is subject to various regulations and oversight by regulatory bodies such as securities commissions or financial authorities. The company must comply with financial reporting requirements, disclosure obligations, and corporate governance standards set by these regulators. It must ensure transparency, accountability, and fair treatment of its shareholders.

Once a company goes public, it has a wider range of responsibilities towards its shareholders and regulators, and it must fulfill these obligations to maintain its status as a publicly traded entity.

Not all companies are publicly traded, and not all companies need external funding. Just look at IKEA and LEGO Group; both of them are private companies that are considered large-cap companies based on their approximate company value.

The largest IPO in the US, UK and the Philippines

A private company that undergoes the IPO process cannot raise capital without disclosing why it needs the money. They need to disclose important company information to their potential investors, such as financial statements, their plans for the company moving forward, where they’ll invest the capital, their management team, their industry, their market share and competitors, and the factors that impose a risk on their business’ profitability, to name a few.

Just think of it like this: if someone asks you for money, would you give it willingly without even asking why that person needs it? Obviously not, because you’ll need a lot more information than that because you’re, knowingly or unknowingly, weighing the risk and reward of giving your money to that person. Will that money come back? Or will this person grow that money if I give it to him? and whatnot. 

Any type of capital financing, whether you’re the one who needs it or the one who will be giving it, requires disclosure, clarity, and communication between both parties.

Giving Clarity to The Previous Examples

Recall that in the “Equity Financing, A Scenario” section of this blog, I used Nico and his tea business as an example.

In that example, before Nico was able to raise capital for expanding his business to one of the busiest cities in his country, he was a sole owner of his business, but after he gave a percentage of his business to Carlos in exchange for £30,000, his sole ownership of the business transformed into a partnership.

Yet Nico and Carlos are still an unincorporated business. This means that both partners are liable for the debts and obligations of the partnership, just as sole owners are.

For instance, the £10,000 debt of Nico and Carlos’ tea business is under their names.

Whereas an incorporated business means that the company is a separate entity from its owners. It provides limited liability protection to the owners (shareholders). This means that the personal assets of the shareholders are generally not at risk in the event of business debts or liabilities. The liability of the shareholders is typically limited to the amount they have invested in the company.

Gener8 is an example of an incorporated company. Currently, they are still a private limited company, and the shares of the company are not being traded on any stock exchanges worldwide.

But in the “Taking Gener8 as an example, What if…” section of this blog, I made a scenario where Gener8 would take the IPO path and now become a public company to raise larger capital for the global expansion of their business.

As a publicly limited company (incorporated) shareholder myself, if one of the companies I am a shareholder of goes into bankruptcy, the company’s creditors will not be looking for me and asking me to pay back the amount of debt of the company relative to the number of shares I own in the company.

Nonetheless, what I’ll lose is my invested capital in the company on a per-share basis as the stock price crashes and there is no dividend payout anymore (if the company had been paying dividends previously).

Knock on wood! I still don’t want this to happen with one of my equity holdings! haha! This is the reason why I don’t invest in the companies; I don’t understand what they do and don’t know their financial statements.

After a successful IPO of a company, what will then be the significance of the relationship between the company, the stock market, and its investors?

As a previously private company now becomes publicly listed, it has received the capital it requires and moves ahead to realise their plans based on what they said they’ll use the raised capital from the IPO for.

Everything seems bright now for the newly public company and their new shareholders. Yet, what stops the management and directors of the company from mismanaging the capital? At the end of the day, they already had the money they needed anyway. What’s the use of their publicly listed status and their connected shareholders (institutional and retail investors)?

Just think about it: why should the company’s management prioritise their shareholders? They don’t have any say in the day-to-day decisions of the management. Shareholders do not add value to the company. Why should they even focus on maximising shareholder value?

It’s simple, because shareholders are the owners of the company.

“Shareholders are the owners of the company, and it is their investment that fuels the engine of growth and prosperity. The management’s duty is to act as faithful stewards of that investment, ensuring that the company’s resources are used wisely and in the best interests of its owners.”

— Warren Buffett

Shareholders are owners

Common shareholders vote on who stays on the board of the company, and the board chooses who will be the CEO. There are other companies where the CEO is also the majority owner of the company, and sometimes even the chairman of the board. This is different for every company.

The board of directors and the managers should make decisions based on the best interests of the shareholders, and this is done by maximising the long-term profitability of the company. But individuals, for most of the time, have their own self-interest in mind regardless of whether shareholders change who sits on the board. 

This is where the principal-agent problem arises, where management or directors go astray from prioritising the shareholders of the company to their own interests, such as wanting more status, power, money, and prestige, and make decisions based on that, which in the long term could erode the overall value of the business rather than expanding it.

Management gets higher pay. Despite the declining earnings of the company, management is making short-term decisions to boost profitability now in order to get the bonuses as they hit targets rather than looking at it on the long-term horizon (this is called short-termism). Consecutive mergers and acquisitions can also become problematic as growth can be mostly short-term. There are factors that hinder overall growth with this method, such as integration challenges as businesses don’t work together properly.

The answer to this is through corporate governance, where systems are placed to control the principal-agent problem. Regulators consistently monitor companies; more transparency is required, including the benefits and salaries of higher management and directors; and company disclosures are required.

Some companies give shares of their company to their employees to incentivize them to grow its overall value. This would be a win-win situation for both the management and shareholders, as stock prices would rise and dividends would be paid (not all companies pay dividends).

“Corporate governance is about promoting corporate fairness, transparency, and accountability to achieve long-term value creation for shareholders and society at large.”

– Paul Polman, former CEO of Unilever

If the company grows, so as your investment in it

“You must thoroughly analyze a company, and the soundness of its underlying businesses, before you buy its stock; you must deliberately protect yourself against serious losses; you must aspire to “adequate,” not extraordinary, performance.”

— Benjamin Graham

Owning shares of a company means putting your hard-earned money on the line. This signifies your interest in being a part owner of a business and its success. By holding its shares, you are betting on the company’s good business performance and for its management to deliver growth to its overall business operations, which in turn will expand and maximise shareholder value.

It is unfortunate, though, that most retail investors don’t have any direct influence on the day-to-day decision-making of a company, but what we do have is the right to vote for who stays on its board and who we think will uphold the best interests of all shareholders of the company. In addition, we also have the choice of whether to continue to be shareholders in the business or not by simply deciding to hold or sell our shares in the company.

NOTE: A retail investor, also known as an individual investor or a small investor, is an individual who buys and sells securities, such as stocks, bonds, and mutual funds, for their personal investment portfolio. Retail investors typically invest smaller amounts of money compared to institutional investors, such as pension funds, hedge funds, or large investment firms.

Not everyone looks at it from the point of view of company ownership, as we have traders and others who only wish the price to go up in order to make money from their initial investment, but for that to happen, the underlying business must do well over a long period of time. Price fluctuates over the short- to medium-term horizon, but in the long run, it always follows the fundamental financial performance of the company.

For additional capital in the future

Once a public company is able to get the share needed, it doesn’t mean that they can get any additional external funding when needed. You see, a public company is already, as its name says, public. It continues to be one, provided that they comply with the government regulators and have great corporate governance.

Any existing public company can always tap into capital, again, through the stock market, on condition that the Securities and Exchange Commission (SEC) approves it.

This is called a secondary offering. 

Let me explain using a real-world example. See the image below.

Let me first tell you the background story of the article above.

In fiscal year 2021, American investment bank Citigroup announced that they will be exiting retail banking in the following markets: Australia, Bahrain, China, Indonesia, India, South Korea, Malaysia, the Philippines, Poland, Russia, Taiwan, Thailand, and Vietnam.

“According to Jane Fraser, CEO of Citi, Citi’s retail arm does not have ‘the scale we need to compete’ in the 13 concerned markets. The banking network said it will now focus on its key strength: institutional banking.

‘We will operate our consumer banking franchise in Asia and EMEA solely from four wealth centres: Singapore, Hong Kong, the U.A.E., and London. This positions us to capture the strong growth and attractive returns the wealth management business offers through these important hubs,’ said Fraser. ” -Esquire

The retail banking segment of Citibank Philippines was acquired by Union Bank of the Philippines (ticker symbol: UBP) for $1.3 billion, which was higher than their initial expected price of $1.1 billion.

Where do you think they got the capital to purchase the Philippine consumer and retail banking arm of Citigroup?

Recall that capital financing can be done in three ways: through the business’ own cash flow, debt financing, or equity financing.

UBP used all three. As they are already a publicly listed company, they can easily tap into additional capital in the stock market. After they got approval from the Securities Exchange Commission (SEC) and the Philippine Stock Exchange (PSE), they went ahead with the stock-rights offering (SRO). The SRO of UBP was successful; they were able to raise 40 billion PHP.

To clearly understand this, see the blog links below.

• Stocks and Shares
• Beware of Share Dilution

So how did UBP raise 40 billion PHP? It’s done by selling more shares of the company to the market at a specific stock market price.

On December 23, 2021, they offered 617.188 million shares at P64.81 a piece.

Multiplying the shares offered by the stock price amount will give them the 40 billion PHP they need.

See two images below for real world secondary offering that happened in the past.

Are all secondary offering bought by its current and potential shareholders?

The answer is no.

If a company is well run, it will have good decision-making skills, capital allocation skills, and risk management skills, which will reflect the company’s financial performance (profit and cash generation, return on invested capital and return on equity, and manageable debt), plus the management’s integrity and be in line with shareholders’ values. What do you think will happen with this type of company in terms of shareholders? Clearly, both institutional and retail investors would want to continue to hold their shares, if not add more, and newer investors would also want a piece of that magnificent company.

Therefore, if such a company wants to raise additional capital through a secondary offering, it is most likely that all of its shares will be sold to the public.

What if we have the opposite qualities of a good company? A management with poor capital allocation and decision-making skills, which is reflected in its financial statements. (poor profit and cash generation, and investment metrics). The directors and management had issues with one another, previous corporate scandals, and accounting fraud. Would you want to be a part-owner of such a company?

Qualities of a good company

As Warren Buffett said. The qualities of a good company that he considers to be good investments are:

He’s been bang on with these five qualities because they summarise the dynamic relationship between a company, the stock market, and its investors.

As a shareholder of a company, what do we actually own?

What do you actually own? Do you own the assets of the company?

Let’s say that you own £100,000 worth of Apple Inc. shares. Can you say that you own a piece of Apple’s headquarters at 1 Infinite Loop, Cupertino, California, USA? (See Apple Inc.’s headquarters image below)

Or maybe because you’ve invested £100,000 worth of your money in Apple, you think you’re entitled to a position in the company? Or maybe you should be owning a small office space there? or maybe boss around people because you’re a part owner of the company. If you’re thinking like this, please just keep it to yourself and not tell anyone because you’ll completely embarrass yourself. 😂

There are differences among shareholders. There are the major shareholders who own a substantial amount of shares of a company and hold power in influencing and making decisions for the company, and there are us, the minority shareholders, who own a small portion of the total company’s outstanding shares.

For us, minority shareholders, we don’t own any of the assets of the company or have a direct influence on the company’s day-to-day decisions.

What we do actually own are shares of the company’s earnings. This is true for all shareholders, whether they are major or minor shareholders.

This is the reason why active shareholders and investors look into the company’s financial performance on a quarterly, half-year, or yearly basis. (I only do it on a yearly basis because I find it impractical to do a quarterly or half year analysis.) If the company and its management perform well, it will reflect in its financial report, and the cash flow that the business receives can be distributed back to its shareholders.

“In what particular way?” you asked.

• Dividends: Some companies distribute a portion of their earnings to their shareholders via dividends. Some companies don’t need the majority of their earnings for reinvestment back into their company due to several factors, such as the company being in the mature stage of its life cycle (slow growers as they’ve reached almost their peak, common with large utility companies), government regulations preventing it from further growing as it can lead to monopolies, to name a few. Because of this, the management decides to give a portion of its earnings to the company’s shareholders.
• Share buyback: Here, management decides to buy back some of the shares being traded in the market. What happens here is that it reduces the number of shares outstanding of the company that are being traded in the market, which increases the percentage of shares owned by current shareholders of the company.

For instance, if you own 150 shares of Company QRS, then its current total number of shares being traded in the market is 15,000.

This means; you own 10% of the company’s QRS. (15,000 shares outstanding divided by your 150 owned shares.)

What if the company buys back 2,000 shares of the 15,000 outstanding shares of the business? This decreases the total number of shares outstanding to 13,000 shares.

Your current ownership percentage now increases to 1.15%. (13,000 shares outstanding divided by your 150 owned shares.)

Then maybe you’re asking, “Well, I didn’t get any money from it, so what’s the point anyway?”

What you said is true, but when you think about it, if the company gives out dividends, then you’ll get more money from it because your share ownership increased.

Company QRS will be giving $1,000,000 worth of dividends to its shareholders this year.

Before the share buyback, the total shares were 15,000. Divide the dividend amount by the total number of shares; £1,000,000 divided by 15,000 shares will give you £33.33 per share. Multiply that by your ownership of 150 shares of the company. That gives you £5,000 worth of dividends for this year.

If company QRS does the share buy back. Then the total number of shares is now 13,000; Divide the dividend amount by the total number of shares; £1,000,000 divided by 13,000 shares will give you £38.46 per share. Multiply that by your ownership of 150 shares of the company. That gives you £5,769.33 worth of dividends for this year.

Nice, isn’t it? 😁

• Reinvestment: if the company reinvests all of the earnings and does not give any dividends to its shareholders or use them for share buybacks, then investors will want to closely monitor its growth and see if the earnings are being reinvested efficiently. Usually, companies will eventually give dividends or do share buybacks in the long run, depending on where the company is in its life cycle. Young and teenage companies are fast growers, and their earnings are heavily reinvested back into the business.

That being said, investors can still make money from this as the company grows because, other than dividends, investors get returns from capital appreciation. As the company’s value expands over time, so does its stock price, as in the long run, stock prices follow a company’s underlying value.

To understand more of what you’ve read above, I highly suggest that you read the following blogs below:

• What are Dividends?
• Share Buyback & Dividends

Mutual Funds

In the previous section, you read about how businesses raise capital, the equity financing route. Then the initial public offering and the relationship between public companies and their shareholders.

Can you just imagine the road travelled by public companies? They were once individuals, partners, or a small group who had dreams and goals. This individual or persons massively scaled their business and realised their plans; some of them stayed privately owned companies while others became publicly listed.

Through the publicly listed route, the initial owners were allowed to share the company’s blessings with other ordinary individuals in this world. It is to become its shareholder and reap the benefits of its business operations. A win-win situation, if you ask me.

Yet, not everyone has the time to learn about the nuances of corporate ownership and be an active investor and shareholder. The financial world has an answer to this, and to make things less complicated for the majority of people, it is through mutual funds.

Mutual fund investment providers are the middlemen in the market. They help not just the non-savvy investors but even the savvy investors to invest their hard-earned money and grow it over time.

Nevertheless, the mutual fund industry is broad, and there are different types of mutual funds that can confuse a lot of people. In this blog, I’ll only focus on passive index mutual funds. It’s the fund I also use for my own investments. I’ll not talk about this in depth because this blog’s focus is with the dynamic relationship of public companies and investors, but if you want to know more, please see the blog link below.

• What is a Mutual Fund?

Public ownership structure if you invest in mutual funds

Mutual funds are also businesses under the financial industry.

They serve as middle men, where they pool money from different investors, and invest those money on assets.

We’ll focus on equity mutual funds.

In equity mutual funds, the fund manager will invest the pooled money from their investors to different public companies

Instead of you making the decision in to what company you’ll be investing your money, doing the capital allocation, risk management and analysis, it’ll be the mutual fund manager and his/her team who’ll be doing it in your behalf.

You, as an individual investor, are also called a retail investor, while the mutual fund company where you’ve invested your money is called an institutional investor. 

What if the mutual fund company where you are invested owns a share of Microsoft Inc.? Who is then the shareholder of the company? Is it you or the mutual fund company that invests on your behalf?

The shareholder of Microsoft Inc. would be the mutual fund company itself.

As an investor in the mutual fund, you indirectly own a portion of the fund’s assets, including its holdings such as shares of Microsoft Inc. The mutual fund company manages the investments on behalf of its investors, pooling their funds together and making investment decisions based on the fund’s objectives. While you have a beneficial interest in the mutual fund’s holdings, the legal ownership of the shares rests with the mutual fund company.

Therefore, you don’t have any voting rights because you don’t directly own any common shares of a specific company. Well, it’s not that big of a deal because not everyone will be interested in such things.

Don’t fret about this; despite not being the direct shareholder of a specific public company that the mutual fund owns, you will still be able to receive dividend income and capital appreciation in this process.

Mutual fund companies pay dividends that they’ve received from their shares of the companies they own, depending on the mutual fund you’ve chosen, because some funds directly reinvest the earned dividends back into the fund; this is called an accumulation fund.

Though the computation of the dividends are different because mutual fund companies compute their returns and the fund’s returns based on its Net Asset Value (NAV). It calculated at the end of each trading day based on the closing prices of the securities in the fund’s portfolio. It takes into account any income earned from dividends, interest, or capital gains, as well as any expenses incurred by the fund.

To Sum It Up

The global equity capital market is one of the largest financial markets worldwide.

It plays a significant role in driving economic growth. In a certain country’s economy, funding or investments from the local population help both the economy and its people grow.

When foreign investments flow into a country, it can stimulate economic growth by providing additional capital for not just private sector businesses but also public sector projects. This influx of capital can fuel expansion, innovation, and the creation of new employment opportunities. It can also enhance infrastructure, such as transportation systems, power plants, and telecommunications networks, which further support economic development.

However, effective capital allocation, sound decision-making, and robust risk management are crucial to ensuring that these investments yield positive outcomes. Proper management of capital resources helps to maximise the impact of investments and mitigate potential risks. It involves strategic planning, evaluating investment opportunities, monitoring performance, and implementing risk mitigation strategies.

By optimising capital allocation and managing risks effectively, the country can harness the potential benefits of both domestic and foreign investments, leading to sustainable economic growth and improved living standards for its people.

At the same time, retail investors and ordinary citizens of the world who are minority shareholders of public companies will also be able to utilise the benefits of the growth of their owned businesses through dividends and capital appreciation.

A word of caution: be careful in which country you’ll be investing your hard-earned money because global capital shies away from countries that are politically, financially, and economically unstable. Just look at what happened in Russia. Both local Russian investors and global investors lost a lot of money as investors fled the Russian equity market due to the heightened political risk since they invaded Ukraine in February 2022.

Lastly, I just want to say that you don’t need to be intelligent and rich to understand these relationships, and certainly you don’t need a degree to be able to invest and ride the growth of the public businesses in your country or even internationally. It’s much better to just do index fund investing for your money that you’ll not need for a minimum of 10 years.

What you need is the time to understand the basic information on how to start, how to open an investment account, to be self-aware and realistic with your money mindset, to know your personal relationship with money, and most importantly, to be consistent with investing.

You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.

—Warren Buffett

Knowledge is my Sword and Patience is my Shield,

elmads

This blog is for informational purposes only and not a Financial Recommendation. Not all information will be accurate. Consult an independent financial professional before making any major financial decisions.