The Value Treasure

Your Guide to Egypt's Stock Market in 2022

2021, a year of divergence

Last year, 2021, will go down in history as yet another extraordinary one for the Egyptian Exchange (EGX). Not only has it seen the market’s two indices diverge in terms of performance, but it also saw a total change of direction at the same time. First, EGX 30 had been hitting a negative note from the beginning of the year until Q4 2021, while EGX 70 EWI delivered a high-flying performance through 8M 2021. Then, EGX 30 pared all its losses since the start of the year to close the year up 10.18% at 11,949.18, while EGX 70 EWI almost wiped out all its gains for the year to close up only 2.64% at 2,201.79. EGX 30 reached its 52-week high of 11,950.34 on 29 December 2021, 0.4% shy of hitting the 12,000 psychological mark—a level we haven’t seen since early March 2020. On the other hand, EGX 70 EWI has witnessed the rise and demise of many of its components, mainly driven by speculative trading behavior that was further fueled by margin trading. This lent itself to a heightened level of volatility that pushed stock prices to unprecedented levels before succumbing to the pressure of forced sales instigated by margin calls.

2022, a year of convergence?

But now that this is all behind us, the question is: How can we bring the lessons we learned from 2021 into 2022? I think 2022 will be a year of convergence between market prices and intrinsic values. What happened in 2021 – in my opinion – will not be repeated in 2022 because we will have a new game in town that will lead to the said convergence in certain stocks.

Five takeaways from the Egyptian stock market

As 2022 continues, I note below five key takeaways from the Egyptian stock market in 2021. I explain how the divergence theme has cropped up in the first place, how the winds of that dynamic will veer back upward in 2022, and how investors could take full advantage of your fresh insight this year.

(1) Speculation, not investing

The first characteristic I note from 2021 is that the Egyptian stock market has been home to speculators rather than investors. After all, speculators care less about a company’s fundamentals, let alone future operational or financial performance. By definition, a speculator is someone who would buy just about anything—literally anything—that is expected to go higher. Regardless of its underlying business, speculators bid a stock higher for the mere hope of its rise, only to sell it at a higher price. On the other hand, last year’s investors, who by nature care about strong fundamentals and high growth potential in the different stocks, seem to have been left out on the sidelines for most of 2021. After all, in a small-cap world where risk is high and fundamentals are weak, investors would have to be lagging the market had they invested in otherwise large caps with low risk and strong fundamentals, which brings us to the second characteristic.

(2) Short-termism, not long-termism

Another characteristic I note from 2021 is the investment time horizon has been prevailing in the Egyptian stock market. It has been a market of short-termism as opposed to long-termism. This is synonymous with a market full of speculators who usually leverage up their trades, translating into very short holding periods to unwind their otherwise costly leveraged positions. While it is understandable how short-termism is prevalent in a market mostly driven by speculators, the twist is that even investors (with supposedly long-term horizons) favored short-termism over long-termism. This characteristic further exacerbated the level of volatility in the market.

(3) Reflexivity, not market efficiency

As debatable as it is, the theory of “reflexivity”, hailed by George Soros, seems to have manifested itself in the Egyptian stock market in 2021. The theory, which is based on a positive feedback loop that is self-reinforcing, explains how markets tend towards economic disequilibrium until they reach an inflection point after which they remain self-reinforcing but in the opposite direction. Reflexivity is usually fueled by high leverage, which is exactly what we experienced in the Egyptian stock market in 2021 in general and in EGX 70 EWI constituents in particular. Indeed, the stock price boom took long to develop (around 18 months), but once EGX 70 EWI reached a peak by end of August 2021, the bust was short term (three months) and steep (-30%) due to the unwinding of leveraged positions. This makes the market a candidate for the weak form of market efficiency as new information coming into the market had little to no bearing on stock prices.

(4) 2D catalysts, not 1D catalyst

When assessing the value of a particular business, we need to be cognizant of the catalysts that will help unlock intrinsic value. This will lead to the convergence I mentioned before, which will eventually close or narrow the positive valuation gap (where fair value is above market price). We could have a one-dimension (1D) catalyst, such as event-driven stories. However, I prefer to have 2-dimension (2D) catalysts, event-driven and growth-driven stories. This increases the probability of convergence. Furthermore, I prefer – whenever possible – to tag along with a company’s investors/founders who are the ultimate business owners and even managers to ensure alignment of interests with shareholders. This, I understand, counters the agency theory which calls for the separation between ownership and management, but we tend to argue otherwise.

(5) Generating cash, not making money

Continuing with my business valuation narrative, I pay close attention to two main line items in the financials: operating earnings and operating cash flow. I believe that any company will only sustain its intrinsic value if its business operations are sound, even if it infrequently lands a windfall from non-core operations and/or investments, which is unsustainable. Thus, an excellent profile to look for would be that of a company wielding strong pricing power and can control its cost with sustainable operating earnings and healthy operating cash flows. I stress on the latter (i.e. operating cash flows) because I think any company can make money or purportedly show so (i.e. an accounting profit), but not every company can generate cash (i.e. an economic profit).

In an attempt to answer the question posed at the beginning (How can we bring the lessons we learned from 2021 into 2022?), I first introduce a simple, yet in my opinion important, matrix to examine where companies fit in terms of having the pricing power and the cost control to be economically profitable. By all means, more research will be required to further recalibrate my matrix which I will explain in more detail in my next article, so stay tuned!

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This article, published as part of Prime Research's STANDPoint 2022 Outlook, has been minorly modified.