Saudi Arabian Equities Preview: Identifying Fundamentally Sound Stocks in Soon to Open Developing Market

Facebook
Twitter
LinkedIn

Saudi Arabia is on track to open its stock market to large foreign institutional investors on June 15. Those who are curious about the sort of companies they will find in this off-limits country can find many answers in MarketGrader’s new 300-stock emerging markets index, the MarketGrader Emerging Markets 300 Index, which includes 37 financially strong and fast-growing Saudi companies.

In developing its new suite of international indexes, MarketGrader decided to include Saudi Arabia, even before it definitively announced the opening of its market. MarketGrader’s decision was based on earlier indications by the Kingdom that it was moving in committed fashion toward this goal, though exact timing was then unclear. Other international indexes could take up to two or three years before they add Saudi components, eventually triggering significant capital from passive funds as well as managers adjusting to adjusted benchmark allocations..

MarketGrader assesses and grades companies on 24 financial indicators that measure growth, value, cash flow and profitability. The highest grades go to companies that are financially strong, have demonstrated persistent growth and whose shares are priced attractively—the very ingredients of the “growth at a reasonable price” investment strategy. Its top-scoring U.S. companies make up the Barron’s 400 Index, which regularly outperforms mainstream benchmarks such as the S&P 500.

The same methodology used to create and maintain the Barron’s 400 (B400) was applied to the new international indexes, 18 of which MarketGrader introduced in April. Like B400, the new indexes have minimum size and liquidity requirements for components, are equally weighted and are reconstituted semi-annually to ensure only companies with the highest grades are included. Today, MarketGrader assesses and scores more than 35,000 companies in 93 countries around the world; 162 of them are in Saudi Arabia (the Kingdom has 168 listed companies total).

This “universe” of Saudi companies has a total market capitalization of US$596.8 billion. Most of them are tiny, but there are more than a handful of giant and large companies. The size details are below in Figure 1. The largest publicly traded company in Saudi Arabia is Saudi Basic Industries Corp., a diversified maker of chemicals, fertilizers and steel products. Its market cap of US$91.8 billion constitutes 15% of the total covered by MarketGrader.

Figure 1. Graded Saudi Companies by Market Capitalization

[ecko_columns][ecko_columns_left]

Number  of Companies Portion of  Total
Mega Cap
(> $10 billion US)
15 9.3%
Large Cap
($3 bln-$10 bln US)
23 14.2%
Mid Cap
($1 bln-$3 bln US)
29 17.9%
Small Cap
($500 mln-$1 bln US)
27 16.7%
Micro Cap
(<$500 mln US)
68 42.0%

[/ecko_columns_left][ecko_columns_right]

[visualizer id=”2558″] [/ecko_columns_right][/ecko_columns]

Almost all sectors are represented in the Saudi market, and in proportions that are typical to emerging and frontier countries. Financials constitute the largest sector. What is surprising in a country that derives its wealth from crude oil is that the energy sector has only one company in it—Rabigh Refining & Petrochemical Co. The production and export of oil is government-owned and controlled by the royal family. Figure 2 shows the sector summary.

Figure 2. Graded Saudi Companies by Sector

Number ofCompanies Portion of Total
Consumer Discretionary 18 11.2%
Consumer Staples 15 9.3%
Energy 1 0.6%
Financials 56 34.8%
Health Care 4 2.5%
Industrials 23 13.7%
Materials 39 24.2%
Technology 0 0.0%
Telecommunications 4 2.5%
Utilities 2 1.2%

 

Saudi Arabia doesn’t have a homegrown technology sector, but it does have one company that “imports” technology. Saudi Advanced Industries Co. is an investment holding company that engages in the transfer of advanced technologies through active participation in industrial joint ventures. In Figure 2 it is classified as an industrial company.

The majority of companies globally don’t get passing scores from MarketGrader, and that is true in Saudi Arabia as well. In the MarketGrader system, scores of 60 or above are “buy” recommendations, and it is from this category that index components are selected. Scores of 50 to 60 are “hold” and those under 50 are “sell.” Scores change as new data is collected, including each trading day’s closing prices. Figure 3 is the current report card for Saudi companies in the MarketGrader coverage universe. 

Figure 3. Saudi Companies’ Grades
[ecko_columns][ecko_columns_left]

Number of Companies Portion of Total
“Buy”
(scores 60 and up)
40 24.7%
“Hold”
(scores 50 to 60)
35 21.6%
“Sell”
(scores below 50)
87 53.7%

[/ecko_columns_left][ecko_columns_right]

[visualizer id=”2544″] [/ecko_columns_right][/ecko_columns]

Of the 40 possibilities, 37 companies were selected for the MarketGrader Emerging Markets 300 Index in March, the most recent reconstitution. (See Figure 8.) The same 37 also are in the MarketGrader Global 1000 Index, which is comprised of the combined components of the MarketGrader Developed Markets 300 Index , B400 and the emerging Index. (Saudi Arabia doesn’t have an individual country index in the MarketGrader family.) In such a merit based index, there is no requirement that every emerging market must be represented at all times. Indeed, no Saudi companies were selected in the September 2014 reconstitution. Likewise, the number of selections from a particular country can and does vary with each review. The average selection from Saudi Arabia is just under 19, and Figure 4 shows how many Saudi companies were chosen in a back-test from year-end 2007 through March 2015.

Figure 4. Saudi Companies in MG Emerging Markets Index
[visualizer id=”2601″]

The 37 Saudi companies in the MG Emerging Markets 300 Index have a total market cap of US$292.9 billion, accounting for almost half of the MarketGrader Saudi universe. The median market cap is US$2.2 billion, squarely in the mid-cap range that is typical of MarketGrader Indexes. The largest is the aforementioned Saudi Basic Industries Corp. The smallest, at US$214 million, is National Agriculture Marketing Co., which markets domestic and imported agricultural products and manages agricultural projects.

Some companies have been selected multiple times, indicating their management’s commitment to financial strength and growth. There were 16 selection periods in the back-test, including the one in which no Saudi companies outscored candidates from other emerging markets. Figure 5 shows those that were selected in more than half of the periods.

Figure 5. Saudi Companies Selected Repeatedly

Ticker Company Sector MarketCap (mln US$) Selection Count Current Selection
2020.SA Saudi Arabian Fertilizer Co. Materials 12,797.08 15 Y
2010.SA Saudi Basic Industries Corp. Materials 91,780.55 14 Y
7020.SA Etihad Etisalat Co. Telecom 7,789.92 14 N
2280.SA Almarai Co. Ltd. Con. Staples 15,106.37 13 Y
1120.SA Al Rajhi Bank Financials 26,956.12 12 N
2330.SA Advanced Petrochemical Co. Materials 2,345.66 11 Y
2230.SA Saudi Chemical Co. Industrials 1,212.12 8 N
2290.SA Yanbu National Petrochemical Co. Materials 7,376.61 8 Y
7010.SA Saudi Telecom Co. Telecom 36,669.98 8 Y

Financial strength can be defined several ways, of course. Figure 6 shows some of the measurements that MarketGrader takes into account in assigning grades.

Figure 6. Fundamentals of 37 Saudi Companies in MG Emerging Markets Index

Median (%) Median
1 Year Net Income Growth 16.83 Return on Earnings 18.15
3 Year Net Income Growth 46.79 Operating Margin (TTM) 25.92
1 Year Sales Growth 9.92 Dividend Yield 2.90
3 Year Sales Growth 30.63 Trailing Price/Earnings 14.75
5 Year EPS Growth 12.83 Price/Book 2.45

As investors know well, the relationship between a company’s fundamentals and the performance of its stock is far from synchronous. Occasionally stocks move markets but more often it is the other way around. Markets respond to economic trends—be they local, regional or global—certain political events and, not least, investor psychology. As they do, they sweep individual stocks along regardless of their companies’ particular circumstances. That’s why MarketGrader believes that reasonably priced stocks of financially strong companies outperform over time.

The stocks MarketGrader selected from Saudi Arabia roughly hold their own with other emerging markets. In 14 back-tested selection periods (not counting the shortened first selection and the current selection, whose performance is incomplete), the Saudi components underperformed MarketGrader Emerging Markets 300 Index as a whole in six. They significantly lagged in cumulative total return since early 2008, gaining 64.4% to the MG Emerging Markets 300 Index’s 85.7%. However, returns depend on the periods being measured. In the final seven selection periods (since September 2011) Saudi components more than doubled the total return of the MG Emerging Markets 300 Index, 71.9% to 31.9%. Figure 7 shows the details.

Figure 7. Performance of EM Index and Its Saudi Components

Start Date End Date EM Index Total Return Saudi Components Total Return Number of Saudi Components
3/24/08 9/19/08 -15.56 -17.62 24
9/22/08 3/20/09 -37.77 -37.69 24
3/23/09 9/18/09 84.23 30.70 23
9/21/09 3/19/10 12.67 7.71 19
3/22/10 9/17/10 11.85 -2.13 12
9/20/10 3/18/11 5.02 9.11 8
3/21/11 9/16/11 -6.62 2.42 10
9/19/11 3/16/12 13.28 18.45 9
3/19/12 9/21/12 -0.38 -3.94 19
9/24/12 3/15/13 14.36 2.95 12
3/18/13 9/20/13 -2.96 8.67 12
9/23/13 3/21/14 -1.71 20.40 27
3/24/14 9/19/14 14.44 25.34 38
9/22/14 3/20/15 -5.18 NULL 0
Cumulative
Total Return 85.68 64.37

When the Saudi stock market makes its debut with foreign investors on June 15, it will immediately join the ranks of important emerging markets because it is the largest by market cap in the Middle East. It is also home to a substantial crop of diversified opportunities, relative to the size of its market, for investors seeking growth at a reasonable price. Eventually, many of these now-unknown companies will become familiar standbys to international and emerging markets investors. Meanwhile, the Saudi components of the MarketGrader Emerging Markets 300 and MarketGrader Global 1000 Indexes can serve as a guide to the financially strongest companies in this soon to open country.

Figure 8. Current Saudi Components of MG Emerging Markets Index[table id=1 /]

Similar Articles

A Chinese Flag

Policy Mistakes Trip Chinese Markets

China’s Damaging Lockdowns Are Informed by Hong Kong’s Deadly Experience Stock market routs in China have usually been preceded by policy mistakes and the latest one is no exception. Government

Read More