A couple of weeks ago, we wrote about the proposal to introduce fractional share trading and reduce the current board lot size for trading on Bursa Malaysia. The stated objective is to improve affordability for small investors to buy stocks. While the intention may be good — to help these small investors invest, earn better returns and build wealth — we highlighted the potential pitfalls and social implications. In a nutshell, if these small investors can only afford to buy stocks in such small bits, then they should not be putting what little savings they have into highly risky assets like stocks.
We presume that the proposal also hopes to improve trading volumes, drive demand and therefore, boost flagging stock prices. It is no secret that Bursa has been a chronic underperformer. Case in point: The FBM KLCI Total Return Index (including dividends) has risen at a meagre compound annual growth rate (CAGR) of 2.2% from 2012 to 2022 — and the FBM KLCI itself has fallen by 11.5%. For some perspective, the Employees Provident Fund paid dividends equivalent to a CAGR of 6%, on average, over this period.
A poor-performing stock market is, rightly, a major concern — it cannot attract capital and investments to support economic activities. But reducing the board lot sizes to boost stock price performance completely misses the point. Yes, improving liquidity may lead to some minor price increases (in particular, for illiquid, highly risky small-cap stocks) but only for a truly short duration of time. Sustained price increases must be underpinned by the rising intrinsic value of stocks, which are, and always will be, driven by growth in underlying cash flows (profits).
The fact is, profits for all Bursa-listed companies have been in broad decline, in the years prior to the Covid-19 pandemic (see Chart 1). As we have said, stock prices are, ultimately, determined by underlying profits. If profits do not grow, then the stock market cannot perform.
Case in point: The US stock market has been the standout performer over the longer term. The CAGR for the S&P 500 Total Return Index (including dividends) was 12.7% between 2012 and 2022. While it is true that valuations have expanded over the past decade, thanks largely to monetary policies, the stock price gains are supported by underlying profit growth.
Chart 2 shows the positive correlation between total profits and market cap for all US-listed companies. This profit growth for listed companies is mirrored by the increase in aggregate domestic profits for the business sector as a whole (in the economy). We explained previously where aggregate business sector profits come from with the Levy-Kalecki profit equation (“‘Greedflation’ stock prices and the policy implications”, published in The Edge dated Sept 25, 2023) (see Chart 3).
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Profits = Investments + dividends + government budget balance + household sector balance + current account balance
Notably, since the global financial crisis, US corporate profits have been driven by private sector investments, dividends and, increasingly, government deficit spending — all of which inject cash into the circular flow in the economy (and into the business sector).
Applying the same Levy-Kalecki profit equation to Singapore, we see the same trend of rising aggregate corporate profits over time (blue line) (see Chart 4). In Singapore’s case, the source of profits growth is primarily dividends, distributed to investors that flow back to the business sector in the form of sales.
However, the Singapore Exchange S68 (SGX) too has underperformed. Total market cap has been flattish while the benchmark STI Total Return Index (including dividends) has risen at a CAGR of 3.8% from 2012 to 2022 — better than the FBM KLCI, but a far cry from the S&P 500 returns. The reason for its underperformance? The broad downtrend in profits for its listed companies (see Chart 5), which contrasts with the growing aggregate corporate profits from the Levy-Kalecki model (Chart 4).
We suspect the reason for this divergence is that the companies listed on the SGX — dominated by the few banks and real estate investment trusts (in terms of market cap) — are not representative of the broader Singapore economy. In other words, there are many unlisted businesses, large and small, including state-owned enterprises, that account for a bigger share of aggregate corporate profits in the economy.
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What about the aggregate profits for the Malaysian business sector? We have already established that Bursa has been a chronic underperformer because profits for listed companies have been falling. Could it be that, like in Singapore, the Bursa-listed companies are not representative of the economy?
We could not replicate the Levy-Kalecki profit equation chart for Malaysia (at least, not with a high degree of confidence) due to insufficient publicly available statistics. The best proxy we can think of is government revenue of corporate tax, since taxes paid are more or less proportional to profits. The stagnation we see in corporate tax paid (see Chart 6) — noticeably from 2014 to 2019 (pre-pandemic) — implies that aggregate corporate profits, too, have been flattish. In other words, the same trend as seen for Bursa-listed companies. If true, this raises some serious questions, chiefly, the fact that even a relatively high 6.5% annual gross domestic product (GDP) growth (on average) during this period could not drive corporate profits higher.
When the economy is growing, it generally means that demand and sales are also growing for businesses — and profits should rise in tandem. Of course, there are sectors that are countercyclical to the broader economy and yet others that are determined by external factors; for instance, global commodity prices. But there should, in general, be a positive correlation between GDP growth and profit growth. So, why has Malaysia’s corporate profit growth been so anaemic against the backdrop of relatively robust GDP growth?
Chart 7 shows that profit margins and return on equity (ROE) for companies listed on Bursa have been in broad decline for years, until the 2020 pandemic. Critically, the margin and ROE declines came even as sales grew. (Let’s ignore the pandemic years of 2020-2022 for now as there are simply too many distortions to derive any trend, what with the sharp profit plunge at the outset, followed by unsustainable record profits for glove makers, plantation firms, and electrical and electronics companies.)
There are several key reasons behind the lacklustre corporate profits. For one, this was a period of falling and low oil prices, which hurt the oil and gas sector’s profitability. Malaysia’s economy, as we well know, remains heavily dependent on commodities (especially oil and gas). At the same time, diversification into the manufacturing sector has been largely stuck at the lower end of the “food chain”, doing subcontracting, competing on costs, and relying on cheap labour rather than on research and development, intellectual property or a knowledge-based workforce. As a result, most of the firms are price takers, lacking market influence. Additionally, this was also a period of declining ringgit value against the US dollar, and Malaysia has relatively high import content (about 43% of manufacturing sales), compared to, say, South Korea’s of less than 35%. The combination of low pricing power, low domestic value added and falling ringgit = falling margins.
No amount of tweaking the trading rules, lot sizes, commission rates and similar inconsequential actions is going to make a difference to the performance of a stock market. Stock prices can only perform with sustained earnings growth and positive prospects.
In short, Bursa’s chronic underperformance is due to anaemic corporate profits, which, to a large extent, reflect the existing structure of our economy. This ties in to our recent series of articles, addressing the economic issues and challenges, including on targeting labour share of income, the need to end state capture and wage intervention. To grow corporate profits and sustainably rejuvenate Bursa as well as raise the people’s wages, Malaysia needs to transform its economy. We need to end state capture and rent-seeking, shift towards the more stable, higher value-added, knowledge-based services sector and move up the manufacturing value chain.
Digital transformation is our best hope to catch up. We will write about what it takes to transform and digitally enable the nation in the near future, not just aspirations but also the foundation — infrastructure, laws and regulations, investments and finances, new materials (data processing, analytics), human resources (training) and so on that are necessary to build this digital ecosystem.
More emphasis needs to be put on the small and medium enterprises, too. They are the largest employers and, quite likely, a potential source that can best drive the economy, especially up the value chain. Positive results can be achieved quickly because the ecosystem is already in place. And what they need are simple: availability of financing, ease of doing business, licensing and non-abusive regimes.
The Malaysian Portfolio gained 0.1% last week, underperforming the benchmark FBM KLCI, which gained 0.7%. Shares for Insas gained 0.6% for the week. Total portfolio returns now stand at 158.5% since inception. This portfolio is outperforming the benchmark FBM KLCI, which is down 20.9%, by a long, long way.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
