Exchange rates, exports and imports

Please note this article is written to refer to South Africa. The concepts are however relevant to all economies.

Some companies listed on the Johannesburg Stock Exchange, actually make their money elsewhere in the world. Most of their income is earned by selling products or services in other countries.

A second fact to consider is that exchange rates between the country where a share is listed and where the share is earning its money, fluctuates.

This means that these earnings for the shareholders depend on the exchange rate. We know by now that earnings determine share prices. Therefore the exchange rates affect the share price of these companies. This is how it works:

Lets compare two exchange rates for a company listed in South Africa, but dealing with either exports or imports from the USA:

When the rand is strong, the exchange rate is around R5.00 to $1.00. When the rand weakens, the exchange rate is around R7.00 to $1.00

The question you really have to answer is: Where does you business earn its money? If your business manufactures in South Africa, and sells in the US, it earns in the US.

Using the example above:

Lets assume you sell a product for 1 dollar: When the rand is strong, you earn R5 for each unit sold. If the rand weakens to R7 to a dollar, you earn R7 selling the same product at a dollar. It is therefore beneficial for exporting companies to have their own currency weaken. Importers have the opposite problem: If they bought a 1 dollar item at R5:$1, it would cost them R5. If the rand weakens to R7:$1, the same product costs them R7.

This knowledge allows you to pick shares in relation to what you expect the exchange rates to do. If you have a reasonable expectation that the local currency will weaken by 20% over the next year, it would be great to buy exporting shares, because their profits – and share prices – will increase even if sales volumes etcetera stay the same.