Do we have a capital allocation problem?
From tuition centers to public companies selling fish
What is the meaning of going public as a company?
For most people, it means that a company that is represented by a ticker (ABCD for example) is available for search in your favourite trading application. That ticker is given a price that fluctuates when the market opens.
Then, people would start looking at price action of said “ABCD” in a bid to determine: “should I buy or should I sell” and aim to maximise profits based on past price point behaviours. For example:
Where are the support lines and resistance lines?
What are the latest news saying about “ABCD”?
How are the influencers or financial analyst covering “ABCD”?
Granted, there are a gazillion ways of making (or losing) money in the stock market. That’s why you will get different opinions regarding “ABCD” at any given point of time, depending on who you ask.
But let’s get to the very very basics.
Why is share “ABCD” available for you to purchase in the first place?
In Principle ABCD is a Business
Yes, ABCD is none other than a business that has a job of making money (read: making profits). It would involve selling a product or service to a well defined market.
How many businesses are there in Indonesia? There are plenty! Our President (Jokowi) claims that there are a whopping 65 million small and medium sized businesses in Indonesia. Again this should be a no brainer, but the goal of these businesses is to make money. They make money to ensure livelihood of owners and their employees.
Out of this 65 million businesses, there is a spectrum. On one extreme, there are businesses that are just starting out and serving 0 customers making 0 dollars. On another extreme, there are businesses that are so enormous and is virtually impossible for us to not know. For those who have a bank in Indonesia, we probably might have heard of BCA.
Most Subscribed Belief on Planet Earth
What is the most subscribed belief on planet earth ever since the industrial revolution? That belief happens to create international cooperation and trades. It also happens to so far be pulling people out of poverty.
That religion is called economic growth.
All nations benchmark their wealth, prosperity and state of accomplishment based on economic output. If you produce a car, you produce an output. You build a rumah toko, you produce an output. You build plantation, you produce an output. That output within the bounds of a single country gets aggregated by macroeconomists and they get called Gross Domestic Product (GDP).
For a country to be prospering, it needs to have a good GDP growth. There is a country in Asia called China that did this pretty well in the 21st century. In the 20th century, that country is Japan. For these countries, their companies excelled in manufacturing goods and exporting them to other countries. That’s why we have a lot of Made in China in 21st century and Made in Japan in 20th century (I’m a millennial and my Gameboy was made in Japan).
Macro Down to Micro
We have not answered our original question yet.
Why is share “ABCD” available for you to purchase in the first place?
When we have seen that countries are incentivised to grow, there is also a natural incentive for businesses to grow. But growth is not free. It always comes at a cost.
I will not use a company with a specific business model as an example. Let’s just use a simple fictional character called Alex. Alex comes from a middle class family and he aspires to be a Doctor. Specifically, he wants to be an Orthopedic (specializing in bones). So the path he takes is straightforward:
He goes for high school that is in the science track. Cost is around $1,000 per year which is important for the school to educate him so that he can grow his knowledge in foundational sciences.
He goes for bachelor’s degree in the UK to be a General Practitioner. Cost is around $30,000 per year which is important so that Alex could learn all things Medicine deeper.
He then interns at the National Health Service (NHS) for his residential. Cost is now Alex’s time. So that Alex can gain some practical experience in handling sick patients.
He finally moves on to specialize to become an Orthopedic in a famous grad school in the U.S. Cost is around $200,000 per year for this so that he grows his knowledge in his area of specialization.
The example above is not to illustrate that becoming a doctor is expensive (everyone knows that), but rather to illustrate growth always comes at a cost (time, money, energy). For a company to grow, like Alex, it also usually needs money.
Now how does a company who needs money to grow gets the money? Alex in the example above may receive money from his parents or rich Aunt, but a company has another channel to source money. That channel is the public!
Based on my conversations with people so far, quite a number has a fuzzy understanding as to why a company goes public. Or what a public company actually represents. Put simply, a company goes public so that they can source money from public investors (like you and me). Investors like you and me obviously want our money back in the future and therefore, we are hoping that we can get returns.
So the company “ABCD” you see in your favourite trading application, is really a company that at some point it was listed, needs money from the public to grow, period.
Unfortunately, I think that quality of “ABCD”s today can be much much improved
Indonesia is an emerging market. Undoubtedly, there will be plenty of companies that are frankly not investible for the long term despite being listed in the stock exchange, unless there are significant changes to business and management. We would be naive to believe that all companies in the stock market is good companies, wouldn’t we?
Exihibit A:
I don’t want to name names, but there is a company that has a tuition center busines that asks for money from public. The core business is tuition center that prepares high school students for university and it seems to be a traditional business.
My thinking immediately goes: “if your business is profitable enough and want to expand, why don’t get a loan from a bank to expand or cash from your operations?”
The company might say that they want to build a “virtual reality” program. But that’s not super clear to us investors.
What virtual reality program?
How do you rapidly gain market share from building this?
Exihibit B:
There is another public company that’s business is to lease property to a high school. That high school (a different private entity) happens to have the same owner as the property leasing business. Without looking much further into the financial statement, we immediately know that this is not investible in the long term.
The examples go on. If interested, you can go to IDX public expose and download a financial statement of a randomly selected public company. Chances are, you will see things that you don’t like which can erode minority shareholder’s confidence in investing for the long term.
There are well over 900 companies that are listed in Indonesia and at present moment, I am of the view that only a small fraction is investible for the long term. Though it appears to be disheartening, it actually tells us that we are early in the game for a promising emerging market like Indonesia.
Why are there not many Investible Companies for the long term?
Here are a few factors that might shed light on the reason why.
We are at the stage of a development where “size” is an unfair advantage.
You can take banks as an example. The larger it gets, the more trusted it also gets. As a result, people deposit their money in the largest banks. Therefore, these largest banks only need to pay minuscule interest (some even charges us for putting money in their bank!).
Smaller banks, like digital banks must entice potential depositors by raising interest rates given to depositors. Consequently, the cost gets higher and it becomes harder for them to grow without the size and reputation that much bigger players have had.
Good companies may not see a reason why they should be listed.
If they can get a loan from a bank at very little interest, perhaps they wouldn’t want their company to be listed so that they can enjoy profits for themselves.
Number of intelligent investors with long term orientation is tiny (or at least their size of capital isn’t that huge yet).
We have to be honest with ourselves and 90+% of the reason why people participate in buying shares in the market today is to speculate in the short term. Plenty of people use feelings and sentiments to FOMO into a stock or fear sell. As a result, stock market becomes more of a place for companies to narrate stories that might be removed from reality.
Closing Remarks
Does the above represent a capital allocation problem? Well, I am of the view that capital allocation is a spectrum. From super inefficient to the perfectly efficient that unrealistically assumes perfect information. Of course, the goal of a society is to make capital allocation more efficient overtime.
The idealism in me wishes for a vehicle that allows investors to be more intelligent with much less effort. Then it would create a healthier ecosystem in the capital market. Good companies that don’t see a reason to be listed might realise that there is a good reason for them to list and be appreciated by intelligent investors.
On the flip side, short term and opportunistic companies that want to take advantage of retail investors get reduced in number.
Capital allocation as we know it, would hopefully be even more efficient. Isn’t that a nice future? 🙂
Awesome thanks