Introduction to Share Trading

Money is better than poverty, if only for financial

reasons Woody Allen
Woody Allens quip sums up this beginners guide to investing in shares. This is a good start to your
education on investing putting your money where it can gain greater returns than just earning
interest in a high-interest account. Investments in shares or stocs !called stocs in the "SA# can be
daunting as there is vast and various amounts o$ in$ormation on investments and everyone is ready and
%illing to tae your money. &ut in this guide' investing is not as comple( as youd thin. This is also proven
by the $act that Australia has the highest personal share investment in the %orld. This guide hopes to give
you better in$ormation in %hich you can mae individual tailored investment decisions' %hile also covering
some basic $inance concepts.
)oing all the research $or this guide has also illustrated the amount o$ short rule*type guides to get rich
quic. There are a plethora o$ guides+ some o$ the ones Ive seen are , Ways to -ae Saving and Investing
.asier' Si( Steps to /etire /ich' 0 /ules o$ Wealth &uilding and .ight Secrets to Improving 1our 2ort$olio
/eturns. Sure' you can read a guide %hich is a page long on ho% to invest your entire savings' but %hat you
put in is %hat you get out. I$ you believe that reading a $e% o$ these guides %ill prepare you $or investment
then you should read this guide be$ore you go any $urther. Investing is not as simple as these guides
make it out to be' but you dont need a 2h) in quantitative statistics to $igure it out.
This guide hopes to break down the jargon and seeming complexities of investing in the financial
markets by maing things as simple as possible. I %ill try my best to remove all the cheesy quips used by
the media and to demysti$y the $inancial marets' %hich almost has as much 3argon as it does quic rich
schemes.
This guide is broen up into sections %hich should mae it easier $or you to get some ans%ers and $ind
speci$ic in$ormation $or the no%ledge you need to start investing.
Why Should I Invest in Shares
I$ you are reading this beginners guide' its most
liely that your savings are currently in a term
deposit !lie an I45)irect deposit# or 3ust sitting in the ban.
The theory behind investing your money is simple and a lot better $or you than letting it sit under the
mattress. In $act' hiding your money under the mattress actually maes you %orse o$$' as in$lation
!remember your grand parents saying ho% they could buy a ilogram o$ lollies $or 6cent in the 6789s: That
is because $1 now buys less than $1 in 19! as the price o$ good and services rises# eats a%ay at your
savings.
"hat is a share#
So be$ore you go spending your money in shares' you are probably %ondering' %hat is a share: When a
company %ants to go public' they $loat their shares on the stoc e(change !Australian Stoc .(change
!AS;# in Australia# %hich raises equity. $y going public% the company is selling a piece of their
company to you. So %hen you buy a share' you own a proportion of the company' this is the equity. In
return' the company taes your money and uses it to invest in their o%n pro3ects' so the company can mae
money and sometimes pay a dividend or other bene$its.
The share maret in recent years has boomed. &eturns on the '()!! !%hich is the top <99 companies
listed on the stoc e(change have been as good' i$ not better than most other investments !such as bonds#
in the long term' but more about returns later. Also' almost hal$ o$ all Australians o%n shares because o$ the
re%ards' but %ith the re%ards comes riss. To be a good investor% understanding the risks in the
investment is the key to being a good investor. This is so that your purchase is a bargain and $e%er
un$oreseen events occur to derail you $rom achieving your investment goal.
Why invest in shares?
When you loo at the richest people in the %orld or the &/Ws rich list' time and time again there is one
characteristic most these people share. They o%n their o%n business. While it is possible to be rich by
inheritance or lottery %innings' the chance o$ that happening to the regular 3oe is highly unliely.
4o% %hat has this got to do %ith shares: %ell' everything. =%ning shares allo%s you to o%n quality
companies. >or e(ample' i$ you had shares in the ?ommon%ealth &an' Telstra or &@2' you are a
shareholder and there$ore a part o%ner o$ the the company. When these companies earn money' so %ill you
!in the $orm o$ capital gro%th A dividends#.
*ow much do you need to invest#
So ho% much do you need to start investing in shares: 1ou can enter the maret %ith as little as B,99'
ho%ever %ith this amount' broerage cost !This is the cost you pay your broer to buyCsell shares' %ith
discount broers such as comsec and eDtrade this can be as lo% as B67.7, * B<7.7, per trade# %ill eat a%ay
a chun o$ your money. -ost people say its best to have around B69'999 so that you can have a relatively
diversi$ied port$olio o$ , shares %ith B<999 invested in each.
I$ you dont have enough $or this' its probably better to invest in a managed $und. As suggested above'
%hen you are a $irst time investor' its probably a bad idea to put all your eggs into one baset. -anage
$unds allo% you to diversi$y your investments $or as little as B6999' though B<999 is more ideal.
Are you /eady To Invest:
1our $irst investment might be $rightening and e(citing' because you do not no% %hen or ho% to start
investing. When you loo at the historical prices o$ some shares' they have gone up and do%n' so ho% do
you no% %hen to 3ump in and start buying:
As a long term investor' the time hori+on for your
investment should be around , years' this is $rom the time you buy to the time you sell. Thus' short term
volatility should not change your decision on %hen to invest. The marets %ill inevitably rise and $all' but
short term volatility should not matter as long as the long term gains are there.
In an earlier section to this guide' %e discuss the importance o$ diversi$ication and share selection. The
shares you select %ill $orm the port$olio in %hich you diversi$y riss. &ut $irstly' you have to as yoursel$ some
questions about your investment goals.
What is your time $rame: < years' , years' 69 years:
@o% ris adverse are you: !Are you %illing to $orego returns $or a less risy investment:#
)o you pre$er capital gro%th over dividend yield !dividend payments#:
In ans%ering these questions' its use$ul to no% ho% shares are categorised' %hat their inherent riss and
returns areE
6. $lue -hip you hear this term in the media commonly and this re$ers to shares %hich are the
most establish in terms o$ stability o$ earnings and history. They generally pay a steady dividend
and maintain steady capital gro%th. These are deemed the least risy shares.
<. Income these shares usually pay a larger dividend to attract investors %ho do not %ant to sell
their shares to generate income. &ecause they are paying dividends' the usually gro% slo%er due
to lo%er reinvestment.
F. .rowth these are usually ne%ly listed shares %hich have high gro%th and have little or no
dividends. In lieu o$ dividends' investors receive a higher capital gro%th' as the company uses the
pro$its to reinvest bac into the business. In recent times' these have been typically technology and
mining shares.
8. -yclical these are lined to the economic cycle %hich means %hen the general economy is
per$orming poorly' these share %ill mirror the general economys per$ormance and $all.
,. /efensive these are the opposite o$ cyclical shares and usually per$orm in the same %ay despite
the economy being in a recession. Typically' companies o$ this nature %ill sell good and services
such as insurance' staple $ood and pharmaceuticals.
A mi(ture o$ the above share %ill provide good diversi$ication in a port$olio' thereby reducing the riss.
@o% )o I 2ic What Share To &uy:
/esearch' research' researchG That0s the key to picking the winners. 5ranted' youre not a quali$ied
$inancial pro$essional %ith access to the in$ormation available to equity analysts' ho%ever you can hire
someone to pic them $or you or you can do it yoursel$' %ith some research and basic in$ormation.
A stoc broer isnt %hat they used to be. The heady days o$ the 67H9s pained a slimy and money*hungry
picture o$ stoc broers but no%adays' %ith more sa$eguards $or investors in place stoc broering is a
competitive industry %ith broers all vying $or your investment dollar.
(tock broker% who#
There is much con$usion over the term broer' as many believe this is the person that you consult and
receive advice $rom %hen you %ant to trade shares this is not the case. A broer is a stoc broing $irm
and o$$er t%o main services. >irstly' a full service broker will offer personalised information and tailored
advice. 1ou can see them more lie a $inancial planner that solely concentrates on equity. 1ou can as them
$or ideas or you can as them $or advice on port$olio mi(. The bene$it o$ having a broer is their access to
in$ormation and ability to obtain shares in oversubscribed $loats !%hen there are more buyers than sellers#.
This type o$ service costs around B6,9 per trade or $or large trades' <.,I o$ the total amount traded.
The second type o$ broers are the execution only type' %hich have seen a great proli$eration in recent
years %ith the most popular being ?ommsec and .DTrade. They simply tae your order and process the
transaction. Typically' each trades cost bet%een B6,*F9' substantially lo%er than %ith a broer.
Which broker should I choose?
I$ you are ne% to the game' it might be use$ul to start %ith a broer and establish i$ they add value to your
o%n research. &e %ary' as they are paid based on the volume you trade' there$ore their incentives may not
be lined to your bene$its.
@o% To &uy and Sell Shares
1our broer or online*broer receives your order and this is entered into AS;s Stoc .(change Automated
Trading System !S.ATS#. &uy and sell orders are sorted $irstly by price' then by time. The system does not
di$$erentiate bet%een broers and online broers'
or the siJe o$ the transaction. &ased on a $irst in' $irst served basis' %hen orders are matched' there is a
simultaneous buy and sell. It might be simpler to thin o$ the AS; is a place to match buyers %ith sellers.
Settlement periods
Some things to eep in mind are the settlement periods. The AS; settles all trades on a TKF basis' %hich
simply means to trans$er o$ o%nership o$ the shares and $lo% o$ $unds bet%een the buyer and the seller
occurs on the third AS; business day a$ter the trade taes place. This does not mean investors are unable
to trade the shares be$ore settlement they can be traded %ithin this three day period but the settlement
can be o$$set %ith any subsequent sales or purchases.
All AS; shares are registered electronically on either the ?learing @ouse .lectronic Sub*register System
!?@.SS# operated by AS; Settlement and Trans$er ?orporation !AST?#' a subsidiary o$ AS;' on behal$ o$
listed companies or on the companies o%n sub*registers.
CHESS sponsor
I$ you elect your broer as your -*1(( sponsor' you %ill get one @I4 $or each broer that sponsors any o$
your shares. Alternatively' you can hold shares in an issuer sponsored $orm on the issuer sponsored sub
register' %hich %ill produce a S/4 $or each parcel o$ shares you o%n. This alternative has the advantage o$
placing orders to sell %ithout the need to provide the relevant S/4.
1our ?@.SS sponsor has access to the relevant @I4 and can sell your shares %ithout having to $irst contact
the companys registry to con$irm your o%nership. A common %ay $or broers to simpli$y the trading process
is accept your shares as security $or amounts outstanding on $uture purchase orders' or as security $or a
margin loan. This also assist as you have a list o$ all your shares sponsored by a particular sponsor on one
consolidated statement' and many broers provide $inancial year end statements %hich are a de$inite help at
ta( time.
Checklist before you place an order to buy or sell shares
Is there a minimum order amount
Where are the $unds coming $rom' i$ you are buying:
I$ you are selling' %hat is the @I4 or S/4:
@o% do you %ant the $unds to be paid' i$ you are selling:
@o% many shares do you %ant to buy or sell:
With the share price' are you e(ecuting at a maret price or a limit order: I$
its a limit order' speci$y the price.
Is your order valid $or the trading day: What i$ no order taes place' do you
%ant to eep the order in place or change any details:
Will the contract note come in the post or by email:
What is the broerage rate $or the order:
And 3ust remember' at the end o$ the day' you %ill receive notices and reports %hich may be over%helming.
's long as you have a system' are organised $rom the beginning and sticing to your investment strategy'
things %ill be much easier and simple' especially around ta( time
@o% to Trade Shares
To trade shares' you must have an account %ith a stoc broing company or an AS; licensed intermediary
!$inancial planner or accountant etc# * this is to
ensure the trading environment is secure and to
ensure you understand the riss involved. -any ne% investors have broers to begin %ith but some pre$er to
do their o%n research and use online broers such as ?omsec and .DTrade.
-ost broers require you to provide $unds in a cash management account ensuring you have the $unds
to process ne% buy orders. =nline broers require you to have an account %ith their associated $inancial
institution be$ore you can begin trading. ?ommsec does not require the $unds in your account be$ore the
trade is entered into' ho%ever .DTrade requires $unds in an investing account' %hich is lined to a cash
management account !or normal savings account#.
Placing an order
When placing a sell order %ith a broer' have the @older Identi$ication 4umber !@I4# or Security holder
/e$erence 4umber !S/4# read as this is proo$ o$ o%nership o$ the shares and this enables the broer to
authorise trans$er o$ the shares to the ne% o%ner.
$uying2(elling shares
When placing a buy or sell order' there are t%o %ays in you can sell. Shares can be traded at market
order %hich means the prevailing maret price %ill be the price at %hich it e(ecutes. The alternative is the
limit order %hich you set the minimum sale price or ma(imum buy price. In this case' it may end up that
the sale price is greater than your minimum and the buy price lo%er than your ma(imum it is the broers
obligation to provide the best price' there$ore you might get a better deal than e(pected.
Who are the shares bought from?
When shares are bought' they are either sold $rom an investor on the AS; or sold directly $rom the institution
in %hich the investor is participating in an Initial 2ublic =$$ering !I2=# %here the company sells their shares
$or the $irst time to investors.
I34s * I2=s or ne% share $loats are %here companies raise ne% $unds $or the purpose o$ e(panding the
business. =nce the company %ishing to $loat registers in$ormation %ith ASI? !Australian Securities and
Investment ?ommission#' a 2rospectus is issued to the public %hich details in$ormation about the
investment. A$ter reading through the 2rospectus and deciding that the company is a sound investment'
investors need to apply $or shares by $illing out a $orm and submitting it to the company %ith payment per
share !based on an indicative amount#.
At the close o$ the subscriptionCapplication period' depending on the popularity o$ the issue' it %ill be either
over*subscribed or under*subscribed. 4ver-subscription %ill usually result in $e%er shares being allocated
to investors as more investors are applying $or the limited amount o$ shares. 5nder-subscription usually
results in investors getting their $ull application o$ shares as demand $or the I2= is lo%er.
I$ the application o$ shares is under the amount o$ shares available to sell' the "nder%riter o$ the issue is
obligated to buy the remaining outstanding shares !i$ one is appointed#. 4ote that there is not one price' but
an indicative price range as the $inal price depends on boo that matches the supply %ith the demand'
%hich is usually managed by an investment ban. Sometimes' the price o$ the issue is not set until one day
be$ore the $loat on the AS;. =nce ne% shares are issued and $loated on the AS;' demand and supply $orces
%ill ic in and the price %ill move based on these maret $orces.
6isted (hares * There are more than 6H99 companies listed on the AS; %hich investors can directly invest
in. .(isting shares have an advantage over I2=s in that demand and supply is transparent' lining to the
liquidity o$ the shares !ho% quicly you can turn your investment into cash and the amount or volume %hich
you can sell !the depth o$ the maret##. Investors can see ho% many people are %illing to sell and ho% many
are %illing to buy at speci$ic prices this transparency is advantageous over investments such as property
%hich has $e% properties $or sale and asing prices are not available.
@o%ever' it should be noted that di$$erent stocs have di$$erent levels o$ liquidity !or demand $rom buyers
and sellers#. ?ommonly' the large blue chip stocks have greater depth and li7uidity' %hereas the lo%er
the maret capitalisation !the maret value o$ the company as calculated by share outstanding multiplied by
the price# the lo%er the liquidity thus this a$$ects the ease o$ selling your shares. Liquidity also a$$ects the
price o$ sharesE i$ the shares have lo% liquidity' investors put a premium on this' meaning the shares are
more e(pensive as it is a disadvantage because it is marginally more di$$icult to convert the shares into
cash.
/is and /e%ards
What happens i$ I mae a mistae and lose money: Lie gambling' many people dont tal about their
losses in the share maret only their gains. This
is a reason $or the hype and also the $ear $irst time
investors have %hen investing in the $inancial marets. &ut %ith a little bit o$ no%ledge and research' most
investors can decide $or themselves ho% they %ant to invest or their ris pro$ile.
So %hat happens %hen things go badly: >irstly' you could lose all your money this occurs %hen a
company does not have enough money to pay their debts even %hen they sell all their assets. The other is
that the share price drops because there %as an adverse event that %as material !impact the stoc price#.
The t%o main riss are that you lose all your money' or you lose some o$ your money.
Invest in 7uality
So ho% do you stop this $rom happening: The $irst ris you can reduce is by picking 7uality companies to
invest in. /esearch is the ey here and more on ho% to pic the %inners later.
Secondly' volatility in share price is due to investor demand and supply' %hich is in$luenced by a number o$
$actors. -ost savvy investors are in $or the long term this is around , years' %here a company is re%arded
$or their long term pro3ects and reap the bene$its. =ver a year' a company %ill do a number o$ things' results
%ill be released' acquisitions' divestments etc' ho%ever i$ you stic %ith the $undamentals' its hard to go
%rong. The fundamentals are relatively simple i$ you believe the underlying business is gro%ing and
their strategies are sound and success$ully e(ecutable then this means their long term $uture is bright.
5iven these strong $undamentals' share prices %ill rise over the long term this is called -apital .ains
!%hen the current price e(ceeds the purchase price#. This is basically 3ust riding out the short term volatility'
%hich has little e$$ect on the long term investor.
Reducing risk diversi!cation
4ne method of reducing your risk is to hold a diversified portfolio. The old saying about never putting
all your eggs in one baset applies to the stoc maret and investing too the only di$$erence is that it is
called diversification. The more diversi$ied you are' the more insulated you %ill be $rom company speci$ic
shocs !be it good or bad# and the more your port$olio %ill re$lect the overall trend o$ the stoc maret.
As a beginner to investing' it is a good idea not to put all your money into the share maret. 2erhaps leave
89I o$ your savings into a high yielding cash account and only invest the other M9I.
Investment Approaches' Strategies and
/ecommendations
Get out of the dollar, teach your children Chinese
and buy as many commodities as you can. Nim /ogers
'n investment approach is an investors strategy to achieve the desired outcome taing into
consideration the riss and re%ards o$ the strategy. Some common strategies are outlined belo%.
Investment strategies
/ay Trading involves trading shares %ithin the day' but sometimes shares can also be held $or a short term
%hich sometimes literally means seconds. "sually' all purchase trades are matched %ith sell trades
throughout the day' meaning there is not an open position !you %ill not o%n any shares# at the end o$ the
day. This is a highly risy investment strategy and requires time in $ront o$ the computer assessing %hen
shares are trending up%ards or do%n%ards and acting immediately. "n$ortunately' there are not many tales
o$ success$ul day traders' so this might be an investment strategy le$t to the believers.
This strategy %as popular during the dot com boom era in the late 6779s %hen most stocs %ere going up
and investors %ere not sophisticated. There %as much tal that everyone %as maing easy money' but
everyone can mae money in a rising maret. When the tough times come' the investors %ith a sound
strategy %ill continue their success.
)ay traders o$ten borro% money to trade+ this is no%n as margin lending !borro%ing to trade shares#.
-argin interests is usually only charged on overnight balances' there$ore investors need to close out the
position be$ore close o$ trade %hich matches the strategys philosophy.
Technical analysis is a $orm o$ analysis %hich sees to mae 3udgements about the per$ormance o$ a share
based solely on its historic and current price behaviour and %ithout re$erence to the underlying business' the
sector the company is in' or the economy as a %hole. This is done by tracing and charting the companys
stoc price' volume o$ shares traded day to day' both on the company itsel$ and also on its competitors.
!httpECC%%%.cper$ormance.comCglossary.htm#
The theory behind it states that historical price movements can indicate the psychology o$ the traders on the
maret and predict the $uture. Technical analysts use various share price charts and indicators to assist in
determining the trend o$ the speci$ic. The analyst is also not concerned %ith %hy the stoc is moving' but the
%ay in %hich it is moving. This $orm o$ analysis is popular %ith day traders as it is typically a short to medium
term trading strategy that aims to provide the investor indicators o$ %hen to enter and e(it the maret.
8undamental analysis is the opposite o$ technical analysis in that it maintains that the marets may
misprice a security in the short run but that the Ocorrect price %ill eventually be reached. 2ro$its can be made
by trading the mispriced security and then %aiting $or the maret to recogniJe the PmistaeP and reprice the
security !Wiipedia#.
>undamental analysts e(amine the $inancial in$ormation provided by each company' as %ell as the industry
and the economy in Australia and overseas. .ssentially' all $actors %hich have an impact on the company.
This then provides a sound picture o$ the per$ormance o$ the company and the resilience against do%nturns.
This is then used to value the company' and used to compare %ith the price in the share maret. When
looing at the data available' $undamental analysts do not try to predict the share price in the short term' as
it is volatile+ they are concerned %ith the long term value %hich is lined to a long term investment strategy.
>undamental analysis is used most %idely by $inancial pro$essionals as it loos at the all aspects o$ the
company. This %as previously di$$icult as the in$ormation available %as di$$icult to compile because o$ the
sheer volumes. With the assistance o$ computers' much o$ the relevant in$ormation can be gathered quicly
and easily !e.g. &loomberg#.
Investment Approaches' Strategies and
/ecommendations
9omentum investing relies on anticipating trends
in prices and volumes and is a $orm o$ technical
analysis. The di$$erence is that the investor %ill buy stocs %hich have an up%ard momentum' assuming it
%ill $ollo% this tra3ectory. This type o$ investor also believes they have a better understanding o$ these Ohot
stocs and can time an entry point and e(it point to ma(imiJe returns. The driver behind momentum stocs
is the psychology o$ the cro%d and the timing o$ the trades.
This is generally a strategy employed by short to medium term investors+ ho%ever some long term investors
also try to use this method.
$uy and hold is a long term investment strategy' %hich theoriJes that $luctuations or declines in the maret
%ill be evened out in the long run' and the $inancial marets %ill provide a good rate o$ return. This contrasts
the day trading strategy %hich is based on the concept that pro$its can be made $rom trading on the peas
and troughs o$ the price' %ithin a day !or %ee#. This strategy suits investors %ho are very conservative and
%ant $e% hassles $rom managing their port$olio. Also' broerage is ept to a minimum.
A common $inance theory is the e$$icient maret hypothesis. This states that i$ every security is valued $airly
at all times' then there is no point in trading. The only time you %ould trade is %hen you need the money.
This theory proves that the buy and hold strategy is the most e$$ective. These theories are good $or
understanding investment strategies' ho%ever as a beginner' it is important to learn %hy investors act the
%ay they do.
This strategy also minimiJes the time you spend %atching and evaluating the per$ormance. The types o$
stocs you purchase $or the buy and hold investment strategy %ill pay dividends regularly' thus providing a
steady $lo% o$ income' in addition to the capital returns %hich are realised i$ you sell. Although these stocs
are usually blue chip' a good investor %ill eep their eye on the underlying per$ormance and ensure that
things are not going %rong. ?omplacency is a danger' as the investor %ill not be able to react to adverse
events i$ una%are o$ them.
Top-down investing begins %ith global economics' both international and national indicators such as 5)2
gro%th rates' in$lation' interest rates' e(change rates' employment rates' productivity rate sand commodity
prices. They then they drill do%n to more speci$ic in$ormation' such as regional and industry analysis %hich
include the siJe o$ the maret' price levels and the e$$ect o$ $oreign competition and barriers to entry. A$ter
this type o$ analysis' the analyst %ill loo at the business itsel$ to establish a value and compare this to the
current maret price.
$ottom-up investing starts %ith speci$ic businesses' regardless o$ their industryCregion. 1ou might have
noticed this is the opposite o$ top do%n investing. The premise behind this approach is that companys
$undamentals are the most important driver o$ value' and that economic trends are di$$icult to decipher. The
aim is to loo at $inancial stability' maret position and the management in the company' to establish i$ it is a
good company to buy despite the economic conditions at the time.
.rowth investing a method o$ investing in a class o$ stocs %hich gro% $aster than other stocs. )uring the
dot com boom' technology shares %ere invested in heavily by all types o$ investors' as the gro%th o$ these
companies %as e(ponential. The gro%th investor loos $or young companies' %hich are o$ten pioneers in
their $ield. They typically trade at relatively high prices compared to their earnings' re$lecting the e(pected
gro%th rates. With this' share prices are usually more volatile than average' dividends are either lo% or non
e(istent !due to reinvestment o$ pro$its in the business $or $urther gro%th#.
:alue investing involves using some $orm o$ bottom up $undamental analysis to establish i$ shares are
underpriced in the maret. This can tae the $orm o$ price*to*earnings ratios' dividend yields or price*to*boo
ratios. This long term investing approach $ocuses on the underlying business.
The basics behind this theory are that investors believe there is an underlying %orth or intrinsic value %hich
is lined to the per$ormance o$ the underlying business. "sing all the in$ormation on the company available'
an estimate o$ the value is undertaen. This is then compared to the share price. Since this is an estimate o$
the value' there needs to be a margin o$ sa$ety' %hich is the second important concept. This margin
ensures that i$ you get things %rong' you still have a bu$$er in your estimate.
A $amous proponent o$ this $orm o$ investing is Warren &u$$et' %ho said he lies to $ind outstanding
companies at sensible prices.
Which Investment Strategy:
1ou have probably heard about the theory that i$ you put a list o$ all the shares on an e(change on a dart
board' and thro% darts at the list' you can probably pic a port$olio that per$orms 3ust as %ell as someone
%ho pics them using value investment techniques.
4e%s papers also lie to play do%n the e(perts
ability to pic the right shares. The 'ge ;ewspaper in 9elbourne% 'ustralia used to run a column in the
&usiness section %hich chose M di$$erent people to pic a baset o$ 69 stocs each and $ollo%ed them
through the course o$ 69 %ees. =$ten' the psychic or teenage girl %ould come out on top.
These types o$ articles are interesting to read i$ you are a short term investor' ho%ever this does not
illustrate the advantages o$ value investing. To the beginner' you might thin that employing a broer is
pointless as they most liely per$orm the same as a random person o$$ the street. This is a fallacy. As you
no%' getting rich quic inherently means you need to tae on additional ris %hich you may not even be
a%are o$. :alue investing which is all about getting rich slow is not easy' but in the long run' people lie
the %orlds second richest man Warren &u$$et has used this technique time and time again to succeed.
It is interesting to note that they are disciplined in %hat they do. 5enerally' they follow two rules' $irstly'
they are independence o$ mind and the second is patience. Independence o$ mind means they do not $ollo%
trends and do not $ollo% the cro%ds in %hat they vie% as a good investment. This means they get to the
shares be$ore anyone else discovers them and can purchase them at a lo%er price. 2atience re$ers to the
long term investment horiJon. Qolatility in share price over a %ee or a month does not re$lect the
$undamental value o$ the share. With the right amount o$ research and a long term vie% o$ F to , years'
value investments should outper$orm the maret.
I$ this does not sound easy' it is because its not. To get some decent returns' you have to do the grudge
%or and invest some time into e$$ort into it. >or those %ho do their home%or' the bene$its %ill pay o$$ and
a$ter some time' you %ill no% ho% to use your tools o$ the trade to more easily pic high per$orming shares.
5ranted' this is not $or everyone' your time $rame might be shorter' or and you might 3ust %ant to $ollo% %hat
is popular in the maret. There is nothing %rong %ith $ollo%ing the cro%ds or $ollo%ing gro%th shares' as
these companies are most liely to be reported in ne%spapers and magaJines.
@o%ever do not be $ooled into thining that other investment techniques are easier to understand and get
better returns quicer. Reep in mind that because most o$ the time' marets are e$$icient' the more pro$its
you mae' the more ris is lined to maing that pro$it. Also' i$ you are trading o$ten' it %ill require more o$
your time and e$$ort.
&orro%ing to &uy Shares
Typically' %hen you buy a house' you borro% money and pay the ban bac. =ver time as the price o$ the
house rises and you pay o$$ your debt' the amount
that you o%n increases. The same theory can be
applied to investing in shares but there are various %ays to use other peoples money to invest. &elo% %ill
outline the advantages and disadvantages o$ each method.
"argin #ending
"sing your e(isting shares as security' you can typically borro% up to 09I. >or e(ample' i$ you have a
port$olio %orth BF9' you can borro% B09' so that your total port$olio is B699. The advantage is that you
can invest using other people<s money and the interest that you pay on the borro%ed $unds is ta(
deductible !assuming that you mae a pro$it#. The disadvantage is that you need an existing portfolio or
cash to secure the loan' and the e(isting port$olio to be included in the security must consist o$ a certain
type o$ stoc' %hich is typically stable and established.
Also' i$ your port$olio loses value' to establish the same ratio o$ 09I borro%ed $unds and F9I security' you
will need to deposit additional cash or shares. This increase in security is called a margin call. The
problem %ith this type o$ gearing is that i$ you do not have additional cash or shares' the ban or
stocbroing $irm %ill require you to liquidate some o$ your e(isting port$olio to pay.
Some $inancial institutions and stoc broers' %hich provide margin lending' only allow you to purchase
stable% less speculative stocks. -ost Australian domestic bans have margin lending available. >or more
in$ormation on margin lending' .DTrade and ?ommsec have good in$ormation.
$sing the e%uity in your home
This is e$$ectively borro%ing $unds' using the equity in your home to secure the debt !assuming you o%n a
su$$icient portion o$ your house' even i$ it is mortgaged#. The danger in this is that i$ you $ind your
investments per$orming poorly' you may lose your house. Also' because debt multiplies your losses' this
might not be a good idea %hen starting out
&eing a &etter Investor
A lot o$ in$ormation is available on the internet' but this might be more o$ a hindrance than actually assisting
%ith your investment goals. ItSs best to stic to the
core tools that an investor uses' %hich are the
tools available $rom your online broer %hich allo%s you to set up your port$olio and %atch lists o$ the shares
you are interested in.
These broers %ill also report the most updated news on the company. In addition to company speci$ic
ne%s' it might be use$ul to read publications $rom the /eserve &an o$ Australia' ho%ever %hen these
publications are released' they are usually summarised in ne%spapers and investor magaJine' %hich are
also good $orms o$ in$ormation.
>or a beginner investor' brokers reports are a useful resource to have' as they are good in breaing
do%n in$ormation and have access to the companies management' %hich other investors can not gain.
These may be hard to $ind and quite e(pensive to get access to' ho%ever i$ you employ a broer to trade
your shares' they %ill have access to these reports and they are able to advise you o$ ho% other broers are
Ho& are my investment going?
2ro$essional investors are usually benchmared against other investors and also the inde(es. 1ou can see i$
your investments are doing %ell by how they compare against the 'll 4rdinaries' %hich is all movement
in the AS; or you can measure it against the top !! stocks on the '()' in the AS;<99 Inde(' or you can
measure it to the specific industry index.
Another good %ay o$ checing the per$ormance o$ your shares is to calculate the dividend yield. )ividend
yield is the percentage return provided to the investor on the stoc. It is calculated by dividing the annual
cash dividend per share' by the stocs maret price at the time o$ purchase.
Success$ul Investors
There are millions o$ boos out there to get you started on your investing 3ourney' but %here do you start and
%ho do you believe: -any people start %ith
success$ul investors and academics %hich have
in$luence $inance theory. These boos might be a bit dense $or the beginner' but this section provides a brie$
summary o$ %ho the most in$luential investors are and ho% they have got to the top.
"arren $uffett
-ost $amous $or being the second richest man in the %orld %ith a laJy "S),,billion' Warren &u$$etts
investment philosophy is centred around value investing. @e %ould buy companies i$ their intrinsic value %as
$ar above the current maret price. Theory goes that the underpricing by the maret %ould be corrected over
time' as marets are e$$icient. @e also believed that the economics behind the company had to be solid.
The belo% are a summary o$ questions to as' %hich %ill determine %hat business to buy' based on the
boo Buffettology by -ary &u$$ett' %ho is a $ormer daughter in la% o$ WarrensE
Is the company in an industry o$ good economics' i.e.' not an industry competing on price points.
)oes the company have a consumer monopoly or brand name that commands loyalty: ?an any
company %ith an abundance o$ resources compete success$ully %ith the company:
Are the =%ner .arnings on an up%ard trend %ith good and consistent margins:
Is the debt*to*equity ratio lo% or is the earnings*to*debt ratio high' i.e. can the company repay debt
even in years %hen earnings are lo%er than average:
)oes the company have high and consistent /eturns on Invested ?apital !his version di$$ers $rom
the popular de$inition#:
)oes the company retain earnings $or gro%th:
The business should not have high maintenance cost o$ operations' lo% capital e(penditure or
investment cash out$lo%. This is not the same as investing to e(pand capacity.
)oes the company reinvest earnings in good business opportunities: )oes management have a
good trac record o$ pro$iting $rom these investments:
Is the company $ree to ad3ust prices $or in$lation:
Interestingly' he has repeatedly criticised the $inancial industry $or %hat he considers to be a proli$eration o$
advisors %ho add no value but are compensated based on the volume o$ business transactions %hich they
$acilitate. @e has pointed to the gro%ing volume o$ stoc trades as evidence that an ever*greater proportion
o$ investorsS gains are going to broers and other middle*men.
$enjamin .raham
Rno%n as the $ather o$ value investing' 5raham taught Warren &u$$ett at the ?olumbia &usiness school.
5raham e(plored the ideas o$ speculation and investment and published a booed called Securities Analysis
in 67F8 %hich is regarded as the best boo on value investing. @e stated that investors should loo at the
underlying business be$ore buying and that it %as numbers that mattered. @e also believed that maret
$luctuations in share prices should be ignored because this only re$lected i$ someone %as %illing to sell a
part in a business at a particular price !this is called the parable o$ -r -aret#.
@is $amous theory on the margin o$ sa$ety %hich states that investors should only buy shares in companies
%here there %as a su$$icient discount to %hat they had calculated as the companys value. This is a basic
concept o$ value investing.
5raham also %rote a booed called The Intelligent Investor in 6787' %hich billionaire Warren &u$$ett
describes as Pby $ar the best boo on investing ever %rittenP. This is echoed by other leading investors such
as Irving Rahn and Walter Schloss.
.eorge (oros
Legendary $or his currency speculation' Soros is a $inancial speculator' stoc investor and philanthropist.
Soros began his career as an arbitrage trader' %hich simply means $inding the same good sold at di$$erent
prices and trading it $or no ris involved.. Where securities are traded on more than one e(change' arbitrage
occurs by simultaneously buying in one and selling on the other.
Soros is the $ounder o$ Soros >und -anagement LL? %hich is a $und manager' %ith various investment
strategies $or various $unds including some controversial hedge $unds such as the Tuantum 5roup o$ >unds.
The investment strategies have been based on analysis o$ real or perceived macroeconomic trends in
various countries. Soros companies have been accused o$ applying pressure on currencies to directly
bene$it their speculative strategies. Soros claims that his $unds tae advantage o$ no%n %eanesses in the
international $inancial system.
@e is best no%n $or his one transaction %hich made him B6.6 billion pro$it' %hich involved speculating on
the &ritish 2ound.
3eter 6ynch
Started in equity research at >idelity Investments in 67MM' he soon graduated to be director o$ research and
in 6700' he %as put in charge o$ the -agellan >und !a mutual $und %hich is a $orm o$ collective investment
that pools money $rom many investors and invests their money in stocs' bonds' short*term money maret
instruments' andCor other securities#. The $und is $amous $or returns o$ <HI !annualised# and gro%th in the
siJe o$ assets $rom B6H million in 6700 to B68 billion in 6779.
Lynch is $amous $or coining terms such as invest in %hat you no% and local no%ledge. @e suggests
that this is a good starting place $or a beginner to invest' as most people do not have time to learn about
complicated quantitative stoc measures or read lengthy $inancial reports. It is easier to become a specialist
in certain industries' in %hich you already have no%ledge. In the boos he has %ritten about investments'
he %rites about some o$ the success$ul investments hes made come $rom %hen he %as out %ith his $amily
or driving to the local shopping centre.
@e %rote a boo called Learn to Earn' %hich is aimed at teenagers %hich may be a good introductory read.
&asic Investment ?oncepts
/iversification
)iversi$ication is sometimes called the only $ree lunch in $inance. It involves investing in various types o$
investments across asset classes' industries' sub*
segments and geographies. The basic premise is
that i$ you have a variety o$ investments' the ris o$ the port$olio is greatly reduced' as your dependence on
one such investment is reduced. This reduction in ris does not equate to a reduction in return !as you %ould
thin# as the mi( o$ investments in your port$olio move to e$$ectively o$$set each other.
3ortfolio
A port$olio is a number o$ shares. T%o shares can $orm a port$olio. 2ort$olios reduce the ris o$ your
investments as they are diversi$ied.
Indexes
Inde(es e$$ectively group shares into categories. The most common inde( in Australia is the All =rdinaries
Inde( %hich is a summary measure' %eighted according to the maret capitalisation o$ the companies. It
also re$lects the current trends in the maret and provides a good benchmar or indicator o$ share maret
reactions to economic events. This is the number that is reported on the ne%s to indicate the general trend
o$ the maret. The AS;<99 is also another commonly quoted inde( %hich lists the top <99 shares on the
AS;. There are also other inde(es $or speci$ic industries and segments' $or e(ample the Industrials'
@ealthcare' ?onsumer Staples' In$ormation Technology' -etals and -ining and many others.
/ividends
=nce a company maes a pro$it' the pro$it must be spent' a$ter paying all the e(penses o$ running the
business. This is commonly spent on either a dividend %hich is in the $orm o$ a cash payment to
shareholders' reinvesting in the business' or in a share buybac' %hich increases the share price. There are
di$$erent reasons and e$$ects o$ all three methods o$ distributing pro$its+ ho%ever dividends are a $orm o$
re%arding the customer $or their investment. In addition' dividends also provide the investor %ith a $raning
credit !or imputation credit#' %hich means that ta( on these earnings have been paid and are an additional
credit to the investor.
$onds
When an organisation requires $unds' it can issue a bond %hich is a type o$ Odebt security !meaning it is a
$orm o$ debt in accounting terms#. Investors pay $or this bond by giving the organisation money' and in
return' the organisation must repay the principal and interest !also called the coupon# at a later date. &onds
are generally issued $or a $i(ed term but are long term !more than 69 years#. In "S terminology' a bill is less
than one year' a note is bet%een one and ten years and a bonds maturity is beyond 69 years.
3rivate 17uity
This is a broad term %hich re$ers to an equity investment in assets that are not $reely tradeable on the public
stoc maret. This is the raising o$ $unds via private marets' as opposed to public marets. Although 2rivate
equity $irms invest in assets %hich %ere not in the public maret they also invest in companies listed on
public e(changes and tae them private. ?ompanies such as RR/ and ??-2 are the largest 2rivate .quity
companies targeting Australian companies.
?ategories o$ private equity investment include leveraged buyout' venture capital' gro%th capital' angel
investing' meJJanine capital and others. 2rivate equity $unds typically control management o$ the companies
in %hich they invest' and o$ten bring in ne% management teams that $ocus on maing the company more
valuable
As they are not listed on an e(change' a private equity $irm o%ning such securities must $ind a buyer in the
absence o$ a traditional maretplace such as a stoc e(change. The Pe(itP or Pselling outP is o$ten achieved
by %ay o$ an initial public o$$ering !I2=#' i.e. $loating the company on a stoc e(change' trade sale or
secondaryCtertiary buy*outs !i.e. sale to another private equity house#
'nnual reports
Annual reports provide an investor %ith detailed $inancial in$ormation' in addition to ma3or activities over the
course o$ the $inancial year. This report is used as the basis $or all value investors' %hich uses the numbers
to deduce ho% the company is per$orming. The $ormat o$ the report is outlined in the AS; listing
requirements' and provides su$$icient in$ormation $or investors to establish ho% their investments are going.
These reports arent restricted to the shareholders and are available in the public domain. These Annual
/eports are usually presented at the Annual 5eneral -eeting !A5-# %here all shareholders are invited to
attend a presentation $rom the &oard o$ )irectors and company .(ecutives o$ ho% the company has
per$ormed and are allo%ed to as questions. "sually' the ?hairman %ill give a run do%n o$ %hat the
company is e(pecting in the upcoming 6< months' %hich is another bit o$ important in$ormation %hich can
prove handy in establishing an investors $uture investment decisions.
-apital gain
The ?apital gain is the di$$erence bet%een the purchase price and sale price' assuming there is a pro$it.
There are no capital gains i$ you do not close out your position !i$ you do not sell#. This capital gain attracts
ta( at your margin rate' %hich is called the capital gains ta(. I$ you o%n the share $or more than 6< months'
ta( is paid on hal$ the gain' %hich is $urther incentive to eep shares longer than 6< months.
-apital losses
?apital losses are the opposite o$ capital gains' in that you mae a loss on the buy and sell trade. This loss
can be used to o$$set against capital gains in the same year. =r' i$ you do not have any capital gains in that
year !you may not have realised your gain#' the Australia Ta(ation =$$ice allo% you to carry them to the ne(t
year' until all used.
To calculate ?apital 5ainsCLosses
6. Total 2roceeds minus Total ?osts !$rom the contract notes#
<. I$ negative' this is a loss' i$ positive' this is a gain
F. i$ you have held these $or more than one year and it is a gain' add hal$ o$ the gain to your ta(able
income.
8. I$ you have held them $or less than one year and it is a gain' add the total gain to your ta(able
income
,. I$ it is a loss' this can be applied to the gains $rom share trading throughout the year.
What are the Ta( Implications:
Ta( is the other side o$ the investing equation. Ta( can change your investment decisions and understanding
ho% this %ors is important because as this
ensures you are acting in a %ay that optimises
%hat goes into your pocet. As ta( payers' all investors must pay ta( on their earnings. The ne(t section
simply e(plains %hat you have to eep in mind %hen e(ecuting trades.
As previously detailed' the e$$ect o$ -apital .ains Tax =-.T> can very easily change your decision to
e(ecute a sell trade. I$ you have high gains $or the year and are %anting to e(it a share you believe %ill be
trading poorly' you may %ant to sell the share to receive a credit to your capital gains.
8ranking credits
>raning credits' also no%n as imputation credits' are earned by investors %ho o%n shares that give out
dividends. This is important' because unlie capital gains ta( on shares !%hich are only applied upon sale#'
dividends must be declared as earnings to the AT= %hether you decide to tae the dividends as cash or to
re*invest.
The %hole idea behind $raning credits is that' companies have already paid the ta( !F9I# on the dividends
distributed' thus avoiding the need to double ta(. >raning credits are then used to o$$set your ta(able
income.
1xampleE
To %or out ho% much the $raning credit is on your dividend' the $ollo%ing $ormula is usedE
>raning ?redit U !Total ?ash )ividend V!699I * F9I## ( F9I
Dassuming this is $ully $raned' meaning the company has paid ta( on this pro$it.
"sing a real li$e e(ample' %e %ill mae the $ollo%ing assumptionsE
-arginal ta( rate o$ 80I
?ash )ividend $ully $raned U ,Mcents
Shares purchased $or B69
4umber o$ shares o%ned U 6999
So i$ %e used the $ormula above %e get the $ollo%ingE
>raning ?redits U !B,M9 V !9.0## ( 9.F
U H99 ( 9.F
U B<89
"hat does this mean#
This means that you have a $raning credit o$ B<89. 4o% say your marginal ta( rate is Jero' you %ill receive
both the dividend !B,M9# and the $raning credits !B<89#.
Tax at top marginal rate =?@A>
"sing $raning credits to your advantage at a higher ta( rate !80I#
?ash dividend B'C B,M9
>raning credit !non*cash# B<89
Total assessable income BH99 !9.,M ; 6999#
Ta( at 80I !BH99 ( 80I# BF0M
Less $raning credit o$$set B<89 !$raning credits' as sho%n above#
4et ta( payable B$C BF0M * B<89 U B6FM
A$ter*ta( return B' - $C B8<8
-ompare this to term deposit or fixed interest
?ash dividend yield !B,M9 C B69'999# ,.M9I
5rossed*up yield !BH99 C B69'999# H.99I
A$ter*ta( yield !B8<8 C B69'999# 8.<8I
?omparing this to a term deposit or $i(ed interest deposit' B,M9 received in interest income is ta(ed at 80I'
%hich means %hat you get in your pocet a$ter ta(es is ,FI o$ the B,M9. This pro$it o$ B<70' is equivalent to
an a$ter ta( yield o$ <.70I on your B69'999. This illustrates that %hat appeared to be a simple and attractive
investment in a term deposit %as not actually a good investment in terms o$ yield.
8.<8I QS <.70I
Share =ptions
=nce you have $igured out shares' there are various %ays you can t%ea and tailor your investments. =ne
o$ the most common methods is to use options' %hich can do a number o$ things' such as reduce the ris'
reduce the initial money you put in' limiting the
trading range depending on the type o$ option
you hold. When trading shares' you usually %ant them to rise' ho%ever %ith options' you can bet many
things' including i$ the share price rises' i$ the share price $alls' i$ the share price remains $lat or i$ the share
price stays %ithin a speci$ic range.
'here are t&o main types of (ptions
6. .quity =ptions !also no%n as .(change Traded =ptions#%hich is the right' but not the obligation
to buy !in the case o$ a call# or sell !in the case o$ a put# shares o$ the underlying security at a
speci$ied price !the strie price# on or be$ore a given date !e(piration day#. A$ter this given date' the
option ceases to e(ist. The seller o$ an option is in turn' obligated to e(ecute a trade on the shares
%ith the buyer o$ the option at the speci$ied price upon the buyerSs request !AS;#.
<. Inde( =ptions give you e(posure to the securities comprising a share maret inde(. They o$$er you
similar $le(ibility to that provided by options over individual stocs' %hile allo%ing you to trade a
vie% on the maret as a %hole' or on the maret sector covered by the particular inde(. Whereas
the value o$ a share option varies according to movements in the value o$ the underlying shares' an
inde( option varies according to movements in the underlying inde( !AS;#.
1ou can either buy put options or call options. 2ut options are the option to sell at a speci$ic price' at or
be$ore the e(piration date. The opposite o$ this is the call option %hich is an option to buy at a speci$ic price'
at or be$ore the e(piration date. =n the other end o$ this are the %riters o$ these options' these are the
people %ho price these options and sell them to investors. This means' i$ you have the option to buy and
sell' then they are obliged to buy and sell i$ you %ish to transact. So i$ you hold a call option and decide to
e(ecute' then the %riter is obliged to sell.
Why (ptions?
They canE
2rotect your shares $rom price volatility' in particular a $all in price
"se your insight to earn income against shares you hold' or are looing to buy
Increase your returns through leverage
)iversi$y your port$olio
>or more in$o on options' have a loo at the AS; %ebsite.