High quality growth at sensible prices to generate sustainable earnings in Sub-Saharan equity markets

Abstract

ABSTRACT Most international equity investors are not really aware of Sub-Saharan Africa’s investment opportunities or, if they are, they do not have concrete plans of how to translate the opportunity into action. High Quality Growth at Sensible Prices (HQGSP) refers to quality investing that accomplishes another dimension of value. The study comprises a sample of 220 listed firms within Sub-Sahara Africa whose profits in the year 2001 were material enough to have been reported. Data retrieved from Bloomberg over a time period of 10 years from 2000 – 2010 in terms of quality of growth, sustainability and price were collected and analysed. An in depth qualitative analysis (economic moat rating) based on the written documents of the firms that fulfilled the criteria of the three above mentioned dimensions was conducted for the year 2010. The firms that fulfilled all these aspects were tested in a simulation from 2011 – 2014 to determine whether or not it will generate outperformance against the MSCI Frontier Markets Africa Index TR and similar strategies. The results of this research reveal that strategies considering only the aspect of value can lead to outperformance, but the genuine advantage of value investing accumulates to investors that consider the aspects of quality, sustainability, price and width of economic moat. Quality and sustainability, measured by low gearing, low standard deviation in earnings, strong year-over-year earnings growth, stable profit margins and sales growth, has the power to generate average returns. The accurate determination of the intrinsic value of a business helps quality investors to prevent acquiring great businesses that are already fully priced. Owning a cheap high-quality business is less risky than the ownership of an overvalued high quality business. A high quality growth investor sees a firm as sensibly priced or undervalued if the intrinsic value is at least 20% higher than the current prices. The two elements, quality of growth and sensible price are interdependent because valuation directly relates to the magnitude, stability and certainty of future earnings growth. Buying undervalued great companies lead to significant abnormal returns over companies that are just inexpensive or are just a great business. Adapting this example to equities in Sub-Sahara Africa, the connection is even more positive.

The HQGSP strategy demonstrated that the higher the quality of a share, the higher the return over low quality shares over time – this result is contrary to the conventional belief on the risk/return conflict. In addition, firms that had a higher quality typically were trading on higher valuations and despite that, have been able to generate higher returns. The message is that equity investors in general, but especially traditional European investors, leave money on the table when firstly they avoid exposure to Sub-Saharan African equity markets and secondly, ignore the quality dimension of value.