The average annualized return on an investment in the most important shares listed on the Bucharest Stock Exchange (BVB) following initial public offerings (IPOs) is around 16%, of which about a third represents the contribution, without reinvestment effect, of the dividend flow that investors benefited from the listing, says Mihai Căruntu, vice president of the Romanian Association of Financial and Banking Analysts (AAFBR).
An essential explanation for such an attractive return is that most companies that listed through public offerings in Bucharest did not go through a tough bear market. From this perspective, the average annualized return of around 10% associated with an investment in OMV Petrom in the almost 22 years since its privatization with OMV has a special significance. The message would be that a long-term effective average annual nominal return of between 10% and 15% for a representative basket of BVB stocks appears realistically achievable for the next 10-20 years, even given the (almost) inevitable incidence of a genuine bear market during this period,
The price at which an initial public offering (IPO) was executed on a stock market undoubtedly represents a significant long-term valuation benchmark for the respective company. This is in fact the most important transaction with a company’s shares and implicitly the respective price constitutes for investors on the capital markets a reference for reporting the performance of the share in question over time. And, depending on the dynamics of the company’s financial results, the developments in the respective sector and the dynamics of international stock markets (incidence of “bull” and/or “bear” markets), the prices of an issuer’s shares may deviate more or less from the execution price of the public offering.
Of course, in the long term, the expectations are that the price of shares issued by a company (and implicitly its capitalization) will increase relative to the IPO price, following the company’s profitability trend relatively synchronously. In fact, profit is the main catalyst for the increase in the market value of a business over time (table I includes the most important IPOs carried out on the BVB regulated market and the performance regarding the dynamics of the companies’ capitalization from listing to the present).
Easy calculation, major significance
The calculation exercise presented involved selecting the most important companies that were the subject of IPOs on the BVB regulated market and for which more than five years have passed since the closing of the public offering, so that there is the minimum time horizon to obtain a statistically reasonable result.
Thus, the shortlist included all the companies with majority state capital that successfully launched offers on the BVB, namely Transelectrica, Transgaz, Romgaz, Electrica and Nuclearelectrica, as well as the important entrepreneurial ones that launched initial public offerings until the incidence of the COVID-19 pandemic. In addition, we added OMV Petrom to this selection, although the flag issuer of the BVB did not list following a public offering. The privatization of the oil and gas producer in July 2004 occurred through a share capital increase transaction. And the quotation at which OMV became the majority shareholder of Petrom is undoubtedly a long-term reference, like the price at which a public sale offer is executed through which a company becomes public. The first component of the performance of an investment in a share obviously refers to the variation of its price for the time interval in question. Thus, for each BVB company, the closing price on the stock exchange on the calculation date and, respectively, the price at which the public offer (or capital increase in the case of Petrom) was executed were considered. This actually represents a potential return, according to the assumption that a share purchased during the public offer period would be sold at the closing price of the reference stock exchange trading session for the calculation exercise. It is worth noting that, given the strong growth market, especially in recent years (the BET index is over 160% higher than the last minimum in October 2022), the average annual increase in quotations appears attractive or very attractive for all issuers taken into account. In such a favorable context, MedLife finds itself in the detached position of the star of the BVB listings with an average annualized increase in the trading price of this company’s shares of over 30%, having as a reference the IPO execution price.
The second component of the return on investment in a share refers to the amount of dividends generated from the listing to the present, compared to the IPO price (or the privatization price in the case of Petrom). Thus, for a large part of the companies that were listed through public offerings, we observe that the level of return obtained by collecting dividends over time is significant in terms of its contribution to the average annualized return of the period. More precisely, this contribution is between 20% and 45% of the average annualized total return for all issuers, except Digi and MedLife (the healthcare company is actually the only one among the issuers that has never distributed dividends). In the case of OMV Petrom and Sphera, the contribution of dividends was at the highest level, namely over 40% of the total return, while Romgaz was in third place with a dividend share of over 30%. For the vast majority of the other selected stocks, the impact of dividend distributions is recorded in the range of 25-30% of the total return to which investors had access.
A very important detail refers to the fact that, for the simplicity of the calculation, we took into account the gross dividends to which investors had access and did not quantify the impact of the reinvestment component of dividends received over time. The compounding effect over time of the value of dividends received annually is, however, significant on the average return generated by the dividend flow collected as a result of holding a stock for the long term.
Statistics document realistic long-term expectations
By adding the capital gain component and the dividend gain component, according to the second table presented, we arrive at the total return accessible to an investor who would have purchased a company’s shares in the initial public offering in order to sell them on the reference date of this calculation exercise. By annualizing the total return based on the time interval that has passed since the listing (or privatization in the case of Petrom), we obtain references of average annualized return between about 6.5% in the case of Sphera and about 30% in the case of MedLife.
By weighting the average annualized return associated with each selected share, with the capitalization of the free-float of the respective issuer, we arrived at an average annualized return of about 16%, without considering a significant reinvestment effect of dividends received over time. Such a benchmark can be considered a strong reference in terms of the performance of an investment in the lowest-risk shares listed on the BVB.
As such, the rates of return targeted by investors in the case of companies operating in Romania with a significantly smaller size, a higher risk profile and unlisted are expected to be correspondingly higher, justifying the request for a premium compared to an average return of around 16%. The calculation thus has concrete practical implications for investors and analysts who seek to substantiate as realistically as possible the level of cost of equity used in their financial models. The cost of equity is in fact an opportunity cost and has the meaning of the level of return expected by investors in accordance with the risk assumed, as it is subjectively perceived by one investor or another.
On the other hand, it is worth noting the registration of a high annualized return of about 10% for OMV Petrom shares, where the calculation takes into account the longest investment horizon among the selected companies (namely a number of over 21.5 years that have passed since the privatization of this company). This period also “captures” the financial crisis of 2008-2009, when the shares suffered a hard bear market. And from this point of view, also taking into account the importance of the issuer for the BVB, there are arguments for OMV Petrom to be considered an authentic reference of potential average return for the Bucharest Stock Exchange in the very long term. We must not forget that, in the event of a bear market, as inevitably happens over long periods of time, the average annualized returns presented in the second table may adjust significantly.
But, of course, a dramatic adjustment would not be possible in principle, in the sense that an average annualized return of between 10% and 15% for a basket of core BVB stocks seems realistic as a benchmark for potential performance for the Bucharest Stock Exchange over the next one to two decades.
