Introduction to Share Trading

“Money is better than poverty, if only for financial

reasons” – Woody Allen

Woody Allen’s 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 stocks (called stocks in the USA) can be
daunting as there is vast and various amounts of information on investments and everyone is ready and
willing to take your money. But in this guide, investing is not as complex as you’d think. This is also proven
by the fact that Australia has the highest personal share investment in the world. This guide hopes to give
you better information in which you can make individual tailored investment decisions, while also covering
some basic finance concepts.

Doing all the research for this guide has also illustrated the amount of short rule-type guides to get rich
quick. There are a plethora of guides; some of the ones I’ve seen are 5 Ways to Make Saving and Investing
Easier, Six Steps to Retire Rich, 7 Rules of Wealth Building and Eight Secrets to Improving Your Portfolio
Returns. Sure, you can read a guide which is a page long on how to invest your entire savings, but what you
put in is what you get out. If you believe that reading a few of these guides will prepare you for investment
then you should read this guide before you go any further. Investing is not as simple as these guides
make it out to be, but you don’t need a PhD in quantitative statistics to figure it out.

This guide hopes to break down the jargon and seeming complexities of investing in the financial
markets by making things as simple as possible. I will try my best to remove all the cheesy quips used by
the media and to demystify the financial markets, which almost has as much jargon as it does quick rich
schemes.

This guide is broken up into sections which should make it easier for you to get some answers and find
specific information for the knowledge you need to start investing.
Why Should I Invest in Shares
If you are reading this beginners guide, it’s most
likely that your savings are currently in a term
deposit (like an INGDirect deposit) or just sitting in the bank.

The theory behind investing your money is simple and a lot better for you than letting it sit under the
mattress. In fact, hiding your money under the mattress actually makes you worse off, as inflation
(remember your grand parents saying how they could buy a kilogram of lollies for 1cent in the 1940’s? That
is because $1 now buys less than $1 in 1920 as the price of good and services rises) eats away at your
savings.

What is a share?
So before you go spending your money in shares, you are probably wondering, what is a share? When a
company wants to “go public”, they float their shares on the stock exchange (Australian Stock Exchange
(ASX) in Australia) which raises “equity”. By going public, the company is selling a piece of their
company to you. So when you buy a share, you own a proportion of the company, this is the “equity”. In
return, the company takes your money and uses it to invest in their own projects, so the company can make
money and sometimes pay a dividend or other benefits.

The share market in recent years has boomed. Returns on the ASX200 (which is the top 200 companies
listed on the stock exchange have been as good, if not better than most other investments (such as bonds)
in the long term, but more about returns later. Also, almost half of all Australians own shares because of the
rewards, but with the rewards comes risks. 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 fewer
unforeseen events occur to derail you from achieving your investment goal.

Why invest in shares?

When you look at the richest people in the world or the BRWs rich list, time and time again there is one
characteristic most these people share. They own their own business. While it is possible to be rich by
inheritance or lottery winnings, the chance of that happening to the regular joe is highly unlikely.

Now what has this got to do with shares? well, everything. Owning shares allows you to own quality
companies. For example, if you had shares in the Commonwealth Bank, Telstra or BHP, you are a
shareholder and therefore a part owner of the the company. When these companies earn money, so will you
(in the form of capital growth & dividends).

How much do you need to invest?

So how much do you need to start investing in shares? You can enter the market with as little as $500,
however with this amount, brokerage cost (This is the cost you pay your broker to buy/sell shares, with
discount brokers such as comsec and e*trade this can be as low as $19.95 - $29.95 per trade) will eat away
a chunk of your money. Most people say it’s best to have around $10,000 so that you can have a relatively
diversified portfolio of 5 shares with $2000 invested in each.

If you don’t have enough for this, it’s probably better to invest in a managed fund. As suggested above,
when you are a first time investor, it’s probably a bad idea to put all your eggs into one basket. Manage
funds allow you to diversify your investments for as little as $1000, though $2000 is more ideal.

Are you Ready To Invest?

Your first investment might be frightening and exciting, because you do not know when or how to start
investing. When you look at the historical prices of some shares, they have gone up and down, so how do
you know when to jump in and start buying?
As a long term investor, the time horizon for your
investment should be around 5 years, this is from the time you buy to the time you sell. Thus, short term
volatility should not change your decision on when to invest. The markets will inevitably rise and fall, but
short term volatility should not matter as long as the long term gains are there.

In an earlier section to this guide, we discuss the importance of diversification and share selection. The
shares you select will form the portfolio in which you diversify risks. But firstly, you have to ask yourself
some questions about your investment goals.

• What is your time frame? 2 years, 5 years, 10 years?

• How risk adverse are you? (Are you willing to forego returns for a less risky investment?)
• Do you prefer capital growth over dividend yield (dividend payments)?

In answering these questions, it’s useful to know how shares are categorised, what their inherent risks and
returns are:

1. Blue Chip – you hear this term in the media commonly and this refers to shares which are the
most establish in terms of stability of earnings and history. They generally pay a steady dividend
and maintain steady capital growth. These are deemed the least risky shares.
2. Income – these shares usually pay a larger dividend to attract investors who do not want to sell
their shares to generate income. Because they are paying dividends, the usually grow slower due
to lower reinvestment.
3. Growth – these are usually newly listed shares which have high growth and have little or no
dividends. In lieu of dividends, investors receive a higher capital growth, as the company uses the
profits to reinvest back into the business. In recent times, these have been typically technology and
mining shares.
4. Cyclical – these are linked to the economic cycle which means when the general economy is
performing poorly, these share will mirror the general economy’s performance and fall.
 5. Defensive – these are the opposite of cyclical shares and usually perform in the same way despite
the economy being in a recession. Typically, companies of this nature will sell good and services
such as insurance, staple food and pharmaceuticals.

A mixture of the above share will provide good diversification in a portfolio, thereby reducing the risks.

How Do I Pick What Share To Buy?

Research, research, research! That’s the key to picking the winners. Granted, you’re not a qualified
financial professional with access to the information available to equity analysts, however you can hire
someone to pick them for you or you can do it yourself, with some research and basic information.

A stock broker isn’t what they used to be. The heady days of the 1980’s pained a slimy and money-hungry
picture of stock brokers but nowadays, with more safeguards for investors in place – stock brokering is a
competitive industry – with brokers all vying for your investment dollar.

Stock broker, who?

There is much confusion over the term “broker”, as many believe this is the person that you consult and
receive advice from when you want to trade shares – this is not the case. A broker is a stock broking firm
and offer two main services. Firstly, a full service broker will offer personalised information and tailored
advice. You can see them more like a financial planner that solely concentrates on equity. You can ask
them for ideas or you can ask them for advice on portfolio mix. The benefit of having a broker is their access
to information and ability to obtain shares in oversubscribed floats (when there are more buyers than
sellers). This type of service costs around $150 per trade or for large trades, 2.5% of the total amount
traded.

The second type of brokers are the “execution only” type, which have seen a great proliferation in recent
years – with the most popular being Commsec and E*Trade. They simply take your order and process the
transaction. Typically, each trades cost between $15-30, substantially lower than with a broker.

Which broker should I choose?

If you are new to the game, it might be useful to start with a broker and establish if they add value to your
own research. Be wary, as they are paid based on the volume you trade, therefore their incentives may not
be linked to your benefits.

How To Buy and Sell Shares

Your broker or online-broker receives your order and this is entered into ASX’s Stock Exchange Automated
Trading System (SEATS). Buy and sell orders are
sorted firstly by price, then by time. The system does not differentiate between brokers and online brokers,
or the size of the transaction. Based on a first in, first served basis, when orders are matched, there is a
simultaneous buy and sell. It might be simpler to think of the ASX is a place to match buyers with sellers.

Settlement periods

Some things to keep in mind are the settlement periods. The ASX settles all trades on a T+3 basis, which
simply means to transfer of ownership of the shares and flow of funds between the buyer and the seller
occurs on the third ASX business day after the trade takes place. This does not mean investors are unable
to trade the shares before settlement – they can be traded within this three day period but the settlement
can be offset with any subsequent sales or purchases.

All ASX shares are registered electronically on either the Clearing House Electronic Sub-register System
(CHESS) operated by ASX Settlement and Transfer Corporation (ASTC), a subsidiary of ASX, on behalf of
listed companies or on the companies’ own sub-registers.

CHESS sponsor

If you elect your broker as your CHESS sponsor, you will get one HIN for each broker that sponsors any of
your shares. Alternatively, you can hold shares in an issuer sponsored form on the issuer sponsored sub
register, which will produce a SRN for each parcel of shares you own. This alternative has the advantage of
placing orders to sell without the need to provide the relevant SRN.

Your CHESS sponsor has access to the relevant HIN and can sell your shares without having to first contact
the company’s registry to confirm your ownership. A common way for brokers to simplify the trading process
is accept your shares as security for amounts outstanding on future purchase orders, or as security for a
margin loan. This also assist as you have a list of all your shares sponsored by a particular sponsor on one
consolidated statement, and many brokers provide financial year end statements which are a definite help at
tax time.

Checklist before you place an order to buy or sell shares

• Is there a minimum order amount

• Where are the funds coming from, if you are buying?
• If you are selling, what is the HIN or SRN?
• How do you want the funds to be paid, if you are selling?
• How many shares do you want to buy or sell?
• With the share price, are you executing at a market price or a limit order? If
it’s a limit order, specify the price.
• Is your order valid for the trading day? What if no order takes place, do you
want to keep the order in place or change any details?
• Will the contract note come in the post or by email?
 • What is the brokerage rate for the order?

And just remember, at the end of the day, you will receive notices and reports which may be overwhelming.
As long as you have a system, are organised from the beginning and sticking to your investment strategy,
things will be much easier and simple, especially around tax time

How to Trade Shares

To trade shares, you must have an account with a stock broking company or an ASX licensed intermediary
(financial planner or accountant etc) - this is to
ensure the trading environment is secure and to
ensure you understand the risks involved. Many new investors have brokers to begin with but some prefer to
do their own research and use online brokers such as Comsec and E*Trade.

Most brokers require you to provide funds in a cash management account – ensuring you have the funds
to process new buy orders. Online brokers require you to have an account with their associated financial
institution before you can begin trading. Commsec does not require the funds in your account before the
trade is entered into, however E*Trade requires funds in an investing account, which is linked to a cash
management account (or normal savings account).

Placing an order

When placing a sell order with a broker, have the Holder Identification Number (HIN) or Security holder
Reference Number (SRN) read as this is proof of ownership of the shares and this enables the broker to
authorise transfer of the shares to the new owner.

Buying/Selling shares
When placing a buy or sell order, there are two ways in you can sell. Shares can be traded at “market
order” which means the prevailing market price will be the price at which it executes. The alternative is the
“limit order” which you set the minimum sale price or maximum buy price. In this case, it may end up that
the sale price is greater than your minimum and the buy price lower than your maximum – it is the broker’s
obligation to provide the best price, therefore you might get a better deal than expected.

Who are the shares bought from?

When shares are bought, they are either sold from an investor on the ASX or sold directly from the institution
– in which the investor is participating in an Initial Public Offering (IPO) where the company sells their shares
for the first time to investors.

IPOs - IPOs or new share floats are where companies raise new funds for the purpose of expanding the
business. Once the company wishing to float registers information with ASIC (Australian Securities and
Investment Commission), a Prospectus is issued to the public which details information about the
investment. After reading through the Prospectus and deciding that the company is a sound investment,
investors need to apply for shares by filling out a form and submitting it to the company with payment per
share (based on an indicative amount).

At the close of the subscription/application period, depending on the popularity of the issue, it will be either
over-subscribed or under-subscribed. Over-subscription will usually result in fewer shares being allocated
to investors as more investors are applying for the limited amount of shares. Under-subscription usually
results in investors getting their full application of shares as demand for the IPO is lower.

If the application of shares is under the amount of shares available to sell, the Underwriter of the issue is
obligated to buy the remaining outstanding shares (if one is appointed). Note that there is not one price, but
an indicative price range as the final price depends on “book” that matches the supply with the demand,
which is usually managed by an investment bank. Sometimes, the price of the issue is not set until one day
before the float on the ASX. Once new shares are issued and floated on the ASX, demand and supply
forces will kick in and the price will move based on these market forces.

Listed Shares - There are more than 1800 companies listed on the ASX which investors can directly invest
in. Existing shares have an advantage over IPOs in that demand and supply is transparent, linking to the
liquidity of the shares (how quickly you can turn your investment into cash and the amount or volume which
you can sell (the depth of the market)). Investors can see how many people are willing to sell and how many
are willing to buy at specific prices – this transparency is advantageous over investments such as property
which has few properties for sale and asking prices are not available.

However, it should be noted that different stocks have different levels of liquidity (or demand from buyers
and sellers). Commonly, the large blue chip stocks have greater depth and liquidity, whereas the lower
the market capitalisation (the market value of the company as calculated by share outstanding multiplied by
the price) the lower the liquidity – thus this affects the ease of selling your shares. Liquidity also affects the
price of shares: if the shares have low liquidity, investors put a premium on this, meaning the shares are
more expensive as it is a disadvantage because it is marginally more difficult to convert the shares into
cash.

Risk and Rewards

What happens if I make a mistake and lose money? Like gambling, many people don’t talk about their
losses in the share market – only their gains. This
is a reason for the hype and also the fear first time
investors have when investing in the financial markets. But with a little bit of knowledge and research, most
investors can decide for themselves how they want to invest – or their “risk profile”.

So what happens when things go badly? Firstly, you could lose all your money – this occurs when a
company does not have enough money to pay their debts – even when they sell all their assets. The other is
that the share price drops because there was an adverse event that was “material” (impact the stock price).
The two main risks are that you lose all your money, or you lose some of your money.

Invest in quality
So how do you stop this from happening? The first risk you can reduce is by picking quality companies to
invest in. Research is the key here – and more on how to pick the winners later.

Secondly, volatility in share price is due to investor demand and supply, which is influenced by a number of
factors. Most savvy investors are in for the long term – this is around 5 years, where a company is rewarded
for their long term projects and reap the benefits. Over a year, a company will do a number of things, results
will be released, acquisitions, divestments etc, however if you stick with the fundamentals, its hard to go
wrong. The fundamentals are relatively simple – if you believe the underlying business is growing and
their strategies are sound and successfully executable – then this means their long term future is bright.
Given these strong fundamentals, share prices will rise over the long term – this is called Capital Gains
(when the current price exceeds the purchase price). This is basically just riding out the short term volatility,
which has little effect on the long term investor.

Reducing risk - diversification

One method of reducing your risk is to hold a diversified portfolio. The old saying about never putting
all your eggs in one basket applies to the stock market and investing too – the only difference is that it is
called diversification. The more diversified you are, the more insulated you will be from company specific
shocks (be it good or bad) and the more your portfolio will reflect the overall trend of the stock market.

As a beginner to investing, it is a good idea not to put all your money into the share market. Perhaps leave
40% of your savings into a high yielding cash account and only invest the other 60%.

Investment Approaches, Strategies and

Recommendations
Get out of the dollar, teach your children Chinese
and buy as many commodities as you can. – Jim Rogers

An investment approach is an investors strategy to achieve the desired outcome – taking into
consideration the risks and rewards of the strategy. Some common strategies are outlined below.

Investment strategies

Day Trading involves trading shares within the day, but sometimes shares can also be held for a short term
– which sometimes literally means seconds. Usually, all purchase trades are matched with sell trades
throughout the day, meaning there is not an open position (you will not own any shares) at the end of the
day. This is a highly risky investment strategy and requires time in front of the computer assessing when
shares are trending upwards or downwards and acting immediately. Unfortunately, there are not many tales
of successful day traders, so this might be an investment strategy left to the believers.

This strategy was popular during the dot com boom era in the late 1990’s when most stocks were going up
and investors were not sophisticated. There was much talk that everyone was making “easy” money, but
everyone can make money in a rising market. When the tough times come, the investors with a sound
strategy will continue their success.
Day traders often borrow money to trade; this is known as margin lending (borrowing to trade shares).
Margin interests is usually only charged on overnight balances, therefore investors need to close out the
position before close of trade – which matches the strategy’s philosophy.

Technical analysis is a form of analysis which seeks to make judgements about the performance of a
share based solely on its historic and current price behaviour and without reference to the underlying
business, the sector the company is in, or the economy as a whole. This is done by tracking and charting the
company’s stock price, volume of shares traded day to day, both on the company itself and also on its
competitors. (http://www.cperformance.com/glossary.htm)

The theory behind it states that historical price movements can indicate the psychology of the traders on the
market and predict the future. Technical analysts use various share price charts and “indicators” to assist in
determining the trend of the specific. The analyst is also not concerned with why the stock is moving, but the
way in which it is moving. This form of analysis is popular with day traders as it is typically a short to medium
term trading strategy that aims to provide the investor indicators of when to enter and exit the market.

Fundamental analysis is the opposite of technical analysis in that it maintains that the markets may
misprice a security in the short run but that the ‘correct’ price will eventually be reached. Profits can be made
by trading the mispriced security and then waiting for the market to recognize the "mistake" and reprice the
security (Wikipedia).

Fundamental analysts examine the financial information provided by each company, as well as the industry
and the economy in Australia and overseas. Essentially, all factors which have an impact on the company.
This then provides a sound picture of the performance of the company and the resilience against downturns.
This is then used to value the company, and used to compare with the price in the share market. When
looking at the data available, fundamental analysts do not try to predict the share price in the short term, as
it is volatile; they are concerned with the long term value – which is linked to a long term investment
strategy.

Fundamental analysis is used most widely by financial professionals as it looks at the all aspects of the
company. This was previously difficult as the information available was difficult to compile because of the
sheer volumes. With the assistance of computers, much of the relevant information can be gathered quickly
and easily (e.g. Bloomberg).
Investment Approaches, Strategies and
Recommendations
Momentum investing relies on anticipating trends in prices and volumes and is a form of technical analysis.
The difference is that the investor will buy stocks which have an upward momentum, assuming it will follow
this trajectory. This type of investor also believes
they have a better understanding of these ‘hot stocks’ and can time an entry point and exit point to maximize
returns. The driver behind momentum stocks is the psychology of the crowd and the timing of the trades.

This is generally a strategy employed by short to medium term investors; however some long term investors
also try to use this method.

Buy and hold is a long term investment strategy, which theorizes that fluctuations or declines in the market
will be evened out in the long run, and the financial markets will provide a good rate of return. This contrasts
the day trading strategy which is based on the concept that profits can be made from trading on the peaks
and troughs of the price, within a day (or week). This strategy suits investors who are very conservative and
want few hassles from managing their portfolio. Also, brokerage is kept to a minimum.

A common finance theory is the efficient market hypothesis. This states that if every security is valued fairly
at all times, then there is no point in trading. The only time you would trade is when you need the money.
This theory proves that the buy and hold strategy is the most effective. These theories are good for
understanding investment strategies, however as a beginner, it is important to learn why investors act the
way they do.

This strategy also minimizes the time you spend watching and evaluating the performance. The types of
stocks you purchase for the buy and hold investment strategy will pay dividends regularly, thus providing a
steady flow of income, in addition to the capital returns which are realised if you sell. Although these stocks
are usually blue chip, a good investor will keep their eye on the underlying performance and ensure that
things are not going wrong. Complacency is a danger, as the investor will not be able to react to adverse
events if unaware of them.

Top-down investing begins with global economics, both international and national indicators such as GDP
growth rates, inflation, interest rates, exchange rates, employment rates, productivity rate sand commodity
prices. They then they drill down to more specific information, such as regional and industry analysis which
include the size of the market, price levels and the effect of foreign competition and barriers to entry. After
this type of analysis, the analyst will look at the business itself to establish a value and compare this to the
current market price.

Bottom-up investing starts with specific businesses, regardless of their industry/region. You might have
noticed this is the opposite of top down investing. The premise behind this approach is that company’s
fundamentals are the most important driver of value, and that economic trends are difficult to decipher. The
aim is to look at financial stability, market position and the management in the company, to establish if it is a
good company to buy despite the economic conditions at the time.

Growth investing a method of investing in a class of stocks which grow faster than other stocks. During the
dot com boom, technology shares were invested in heavily by all types of investors, as the growth of these
companies was exponential. The growth investor looks for young companies, which are often pioneers in
their field. They typically trade at relatively high prices compared to their earnings, reflecting the expected
growth rates. With this, share prices are usually more volatile than average, dividends are either low or non
existent (due to reinvestment of profits in the business for further growth).

Value investing involves using some form of bottom up fundamental analysis to establish if shares are
underpriced in the market. This can take the form of price-to-earnings ratios, dividend yields or price-to-book
ratios. This long term investing approach focuses on the underlying business.

The basics behind this theory are that investors believe there is an underlying worth or “intrinsic value” which
is linked to the performance of the underlying business. Using all the information on the company available,
an estimate of the value is undertaken. This is then compared to the share price. Since this is an estimate of
the value, there needs to be a “margin of safety”, which is the second important concept. This margin
ensures that if you get things wrong, you still have a buffer in your estimate.

A famous proponent of this form of investing is Warren Buffet, who said he likes to find outstanding
companies at sensible prices.

Which Investment Strategy?

You have probably heard about the theory that if you put a list of all the shares on an exchange on a dart
board, and throw darts at the list, you can probably pick a portfolio that performs just as well as someone
who picks them using value investment techniques.
News papers also like to play down the experts’
ability to pick the right shares. The Age Newspaper in Melbourne, Australia used to run a column in the
Business section which chose 6 different people to pick a basket of 10 stocks each and followed them
through the course of 10 weeks. Often, the psychic or teenage girl would come out on top.

These types of articles are interesting to read if you are a short term investor, however this does not
illustrate the advantages of value investing. To the beginner, you might think that employing a broker is
pointless as they most likely perform the same as a random person off the street. This is a fallacy. As you
know, getting rich quick inherently means you need to take on additional risk which you may not even be
aware of. Value investing which is all about getting rich slow is not easy, but in the long run, people like
the world’s second richest man Warren Buffet has used this technique time and time again to succeed.

It is interesting to note that they are disciplined in what they do. Generally, they follow two rules, firstly,
they are independence of mind and the second is patience. Independence of mind means they do not follow
trends and do not follow the crowds in what they view as a good investment. This means they get to the
shares before anyone else discovers them and can purchase them at a lower price. Patience refers to the
long term investment horizon. Volatility in share price over a week or a month does not reflect the
fundamental value of the share. With the right amount of research and a long term view of 3 to 5 years,
value investments should outperform the market.

If this does not sound easy, it is because it’s not. To get some decent returns, you have to do the grudge
work and invest some time into effort into it. For those who do their homework, the benefits will pay off and
after some time, you will know how to use your tools of the trade to more easily pick high performing shares.
Granted, this is not for everyone, your time frame might be shorter, or and you might just want to follow what
is popular in the market. There is nothing wrong with following the crowds or following growth shares, as
these companies are most likely to be reported in newspapers and magazines.

However do not be fooled into thinking that other investment techniques are easier to understand and get
better returns quicker. Keep in mind that because most of the time, markets are efficient, the more profits
you make, the more risk is linked to making that profit. Also, if you are trading often, it will require more of
your time and effort.

Borrowing to Buy Shares

Typically, when you buy a house, you borrow money and pay the bank back. Over time as the price of the
house rises and you pay off your debt, the amount
that you own increases. The same theory can be
applied to investing in shares but there are various ways to use other people’s money to invest. Below will
outline the advantages and disadvantages of each method.

Margin Lending

Using your existing shares as security, you can typically borrow up to 70%. For example, if you have a
portfolio worth $30k, you can borrow $70k, so that your total portfolio is $100k. The advantage is that you
can invest using other people's money and the interest that you pay on the borrowed funds is tax
deductible (assuming that you make a profit). The disadvantage is that you need an existing portfolio or
cash to secure the loan, and the existing portfolio to be included in the security must consist of a certain
type of stock, which is typically stable and established.

Also, if your portfolio loses value, to establish the same ratio of 70% borrowed funds and 30% security, you
will need to deposit additional cash or shares. This increase in security is called a margin call. The
problem with this type of gearing is that if you do not have additional cash or shares, the bank or
stockbroking firm will require you to liquidate some of your existing portfolio to pay.
Some financial institutions and stock brokers, which provide margin lending, only allow you to purchase
stable, less speculative stocks. Most Australian domestic banks have margin lending available. For more
information on margin lending, E*Trade and Commsec have good information.

Using the equity in your home

This is effectively borrowing funds, using the equity in your home to secure the debt (assuming you own a
sufficient portion of your house, even if it is mortgaged). The danger in this is that if you find your
investments performing poorly, you may lose your house. Also, because debt multiplies your losses, this
might not be a good idea when starting out

Being a Better Investor

A lot of information is available on the internet, but this might be more of a hindrance than actually assisting
with your investment goals. It's best to stick to the
core tools that an investor uses, which are the
tools available from your online broker which allows you to set up your portfolio and watch lists of the shares
you are interested in.

These brokers will also report the most updated news on the company. In addition to company specific
news, it might be useful to read publications from the Reserve Bank of Australia, however when these
publications are released, they are usually summarised in newspapers and investor magazine, which are
also good forms of information.

For a beginner investor, brokers reports are a useful resource to have, as they are good in breaking
down information and have access to the companies management, which other investors can not gain.
These may be hard to find and quite expensive to get access to, however if you employ a broker to trade
your shares, they will have access to these reports and they are able to advise you of how other brokers are

How are my investment going?

Professional investors are usually benchmarked against other investors and also the indexes. You can see if
your investments are doing well by how they compare against the All Ordinaries, which is all movement
in the ASX or you can measure it against the top 200 stocks on the ASX, in the ASX200 Index, or you can
measure it to the specific industry index.

Another good way of checking the performance of your shares is to calculate the dividend yield. Dividend
yield is the percentage return provided to the investor on the stock. It is calculated by dividing the annual
cash dividend per share, by the stock’s market price at the time of purchase.

Successful Investors
There are millions of books out there to get you started on your investing journey, but where do you start
and who do you believe? Many people start with
successful investors and academics which have
influence finance theory. These books might be a bit dense for the beginner, but this section provides a brief
summary of who the most influential investors are and how they have got to the top.

Warren Buffett
Most famous for being the second richest man in the world with a lazy USD55billion, Warren Buffett’s
investment philosophy is centred around value investing. He would buy companies if their intrinsic value was
far above the current market price. Theory goes that the underpricing by the market would be corrected over
time, as markets are efficient. He also believed that the economics behind the company had to be solid.

The below are a summary of questions to ask, which will determine what business to buy, based on the
book Buffettology by Mary Buffett, who is a former daughter in law of Warren’s:

• Is the company in an industry of good economics, i.e., not an industry competing on price points.
Does the company have a consumer monopoly or brand name that commands loyalty? Can any
company with an abundance of resources compete successfully with the company?
• Are the Owner Earnings on an upward trend with good and consistent margins?
• Is the debt-to-equity ratio low or is the earnings-to-debt ratio high, i.e. can the company repay debt
even in years when earnings are lower than average?
• Does the company have high and consistent Returns on Invested Capital (his version differs from
the popular definition)?
• Does the company retain earnings for growth?
• The business should not have high maintenance cost of operations, low capital expenditure or
investment cash outflow. This is not the same as investing to expand capacity.
• Does the company reinvest earnings in good business opportunities? Does management have a
good track record of profiting from these investments?
• Is the company free to adjust prices for inflation?

Interestingly, he has repeatedly criticised the financial industry for what he considers to be a proliferation of
advisors who add no value but are compensated based on the volume of business transactions which they
facilitate. He has pointed to the growing volume of stock trades as evidence that an ever-greater proportion
of investors' gains are going to brokers and other middle-men.

Benjamin Graham
Known as the father of value investing, Graham taught Warren Buffett at the Columbia Business school.
Graham explored the ideas of speculation and investment and published a booked called Securities
Analysis in 1934 which is regarded as the best book on value investing. He stated that investors should look
at the underlying business before buying and that it was numbers that mattered. He also believed that
market fluctuations in share prices should be ignored because this only reflected if someone was willing to
sell a part in a business at a particular price (this is called the parable of Mr Market).
His famous theory on the margin of safety which states that investors should only buy shares in companies
where there was a sufficient discount to what they had calculated as the company’s value. This is a basic
concept of value investing.

Graham also wrote a booked called The Intelligent Investor in 1949, which billionaire Warren Buffett
describes as "by far the best book on investing ever written". This is echoed by other leading investors such
as Irving Kahn and Walter Schloss.

George Soros
Legendary for his currency speculation, Soros is a financial speculator, stock investor and philanthropist.
Soros began his career as an arbitrage trader, which simply means finding the same good sold at different
prices and trading it for no risk involved.. Where securities are traded on more than one exchange, arbitrage
occurs by simultaneously buying in one and selling on the other.

Soros is the founder of Soros Fund Management LLC which is a fund manager, with various investment
strategies for various funds including some controversial hedge funds such as the Quantum Group of Funds.
The investment strategies have been based on analysis of real or perceived macroeconomic trends in
various countries. Soros’ companies have been accused of applying pressure on currencies to directly
benefit their speculative strategies. Soros claims that his funds take advantage of known weaknesses in the
international financial system.

He is best known for his one transaction which made him $1.1 billion profit, which involved speculating on
the British Pound.

Peter Lynch
Started in equity research at Fidelity Investments in 1966, he soon graduated to be director of research and
in 1977, he was put in charge of the Magellan Fund (a mutual fund which is a form of collective investment
that pools money from many investors and invests their money in stocks, bonds, short-term money market
instruments, and/or other securities). The fund is famous for returns of 28% (annualised) and growth in the
size of assets from $18 million in 1977 to $14 billion in 1990.

Lynch is famous for coining terms such as “invest in what you know” and “local knowledge”. He suggests
that this is a good starting place for a beginner to invest, as most people do not have time to learn about
complicated quantitative stock measures or read lengthy financial reports. It is easier to become a specialist
in certain industries, in which you already have knowledge. In the books he has written about investments,
he writes about some of the successful investments he’s made come from when he was out with his family
or driving to the local shopping centre.

He wrote a book called Learn to Earn, which is aimed at teenagers which may be a good introductory read.

Basic Investment Concepts

Diversification
Diversification is sometimes called the only free lunch in finance. It involves investing in various types of
investments across asset classes, industries, sub-
segments and geographies. The basic premise is
that if you have a variety of investments, the risk of the portfolio is greatly reduced, as your dependence on
one such investment is reduced. This reduction in risk does not equate to a reduction in return (as you would
think) as the mix of investments in your portfolio move to effectively offset each other.

Portfolio
A portfolio is a number of shares. Two shares can form a portfolio. Portfolios reduce the risk of your
investments as they are diversified.

Indexes
Indexes effectively group shares into categories. The most common index in Australia is the All Ordinaries
Index which is a summary measure, weighted according to the market capitalisation of the companies. It
also reflects the current trends in the market and provides a good benchmark or indicator of share market
reactions to economic events. This is the number that is reported on the news to indicate the general trend
of the market. The ASX200 is also another commonly quoted index which lists the top 200 shares on the
ASX. There are also other indexes for specific industries and segments, for example the Industrials,
Healthcare, Consumer Staples, Information Technology, Metals and Mining and many others.

Dividends
Once a company makes a profit, the profit must be spent, after paying all the expenses of running the
business. This is commonly spent on either a dividend which is in the form of a cash payment to
shareholders, reinvesting in the business, or in a share buyback, which increases the share price. There are
different reasons and effects of all three methods of distributing profits; however dividends are a form of
rewarding the customer for their investment. In addition, dividends also provide the investor with a franking
credit (or imputation credit), which means that tax on these earnings have been paid and are an additional
credit to the investor.

Bonds
When an organisation requires funds, it can issue a bond which is a type of ‘debt security’ (meaning it is a
form of debt in accounting terms). Investors pay for 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. Bonds
are generally issued for a fixed term but are long term (more than 10 years). In US terminology, a bill is less
than one year, a note is between one and ten years and a bonds maturity is beyond 10 years.

Private Equity
This is a broad term which refers to an equity investment in assets that are not freely tradeable on the public
stock market. This is the raising of funds via private markets, as opposed to public markets. Although Private
equity firms invest in assets which were not in the public market they also invest in companies listed on
public exchanges and take them private. Companies such as KKR and CCMP are the largest Private Equity
companies targeting Australian companies.

Categories of private equity investment include leveraged buyout, venture capital, growth capital, angel
investing, mezzanine capital and others. Private equity funds typically control management of the companies
in which they invest, and often bring in new management teams that focus on making the company more
valuable

As they are not listed on an exchange, a private equity firm owning such securities must find a buyer in the
absence of a traditional marketplace such as a stock exchange. The "exit" or "selling out" is often achieved
by way of an initial public offering (IPO), i.e. floating the company on a stock exchange, trade sale or
secondary/tertiary buy-outs (i.e. sale to another private equity house)

Annual reports
Annual reports provide an investor with detailed financial information, in addition to major activities over the
course of the financial year. This report is used as the basis for all value investors, which uses the numbers
to deduce how the company is performing. The format of the report is outlined in the ASX listing
requirements, and provides sufficient information for investors to establish how their investments are going.
These reports aren’t restricted to the shareholders and are available in the public domain. These Annual
Reports are usually presented at the Annual General Meeting (AGM) where all shareholders are invited to
attend a presentation from the Board of Directors and company Executives of how the company has
performed and are allowed to ask questions. Usually, the Chairman will give a run down of what the
company is expecting in the upcoming 12 months, which is another bit of important information which can
prove handy in establishing an investors future investment decisions.

Capital gain
The Capital gain is the difference between the purchase price and sale price, assuming there is a profit.
There are no capital gains if you do not close out your position (if you do not sell). This capital gain attracts
tax at your margin rate, which is called the capital gains tax. If you own the share for more than 12 months,
tax is paid on half the gain, which is further incentive to keep shares longer than 12 months.

Capital losses
Capital losses are the opposite of capital gains, in that you make a loss on the buy and sell trade. This loss
can be used to offset against capital gains in the same year. Or, if you do not have any capital gains in that
year (you may not have realised your gain), the Australia Taxation Office allow you to carry them to the next
year, until all used.

To calculate Capital Gains/Losses

1. Total Proceeds minus Total Costs (from the contract notes)

2. If negative, this is a loss, if positive, this is a gain
3. if you have held these for more than one year and it is a gain, add half of the gain to your taxable
income.
 4. If you have held them for less than one year and it is a gain, add the total gain to your taxable
income
5. If it is a loss, this can be applied to the gains from share trading throughout the year.

What are the Tax Implications?

Tax is the other side of the investing equation. Tax can change your investment decisions and
understanding how this works is important because
as this ensures you are acting in a way that
optimises what goes into your pocket. As tax payers, all investors must pay tax on their earnings. The next
section simply explains what you have to keep in mind when executing trades.

As previously detailed, the effect of Capital Gains Tax (CGT) can very easily change your decision to
execute a sell trade. If you have high gains for the year and are wanting to exit a share you believe will be
trading poorly, you may want to sell the share to receive a credit to your capital gains.

Franking credits
Franking credits, also known as imputation credits, are earned by investors who own shares that give out
dividends. This is important, because unlike capital gains tax on shares (which are only applied upon sale),
dividends must be declared as earnings to the ATO whether you decide to take the dividends as cash or to
re-invest.

The whole idea behind franking credits is that, companies have already paid the tax (30%) on the dividends
distributed, thus avoiding the need to double tax. Franking credits are then used to offset your taxable
income.

Example:
To work out how much the franking credit is on your dividend, the following formula is used:

Franking Credit = (Total Cash Dividend ÷(100% - 30%)) x 30%

*assuming this is fully franked, meaning the company has paid tax on this profit.

Using a real life example, we will make the following assumptions:

• Marginal tax rate of 47%

• Cash Dividend fully franked = 56cents
• Shares purchased for $10
• Number of shares owned = 1000

So if we used the formula above we get the following:

Franking Credits = ($560 ÷ (0.7)) x 0.3

 = 800 x 0.3
= $240

What does this mean?

This means that you have a franking credit of $240. Now say your marginal tax rate is zero, you will receive
both the dividend ($560) and the franking credits ($240).

Tax at top marginal rate (47%)

Using franking credits to your advantage at a higher tax rate (47%)

Cash dividend [A] $560

Franking credit (non-cash) $240
Total assessable income $800 (0.56 X 1000)
Tax at 47% ($800 x 47%) $376
Less franking credit offset $240 (franking credits, as shown above)
Net tax payable [B] $376 - $240 = $136
After-tax return [A - B] $424

Compare this to term deposit or fixed interest

Cash dividend yield ($560 / $10,000) 5.60%
Grossed-up yield ($800 / $10,000) 8.00%
After-tax yield ($424 / $10,000) 4.24%

Comparing this to a term deposit or fixed interest deposit, $560 received in interest income is taxed at 47%,
which means what you get in your pocket after taxes is 53% of the $560. This profit of $297, is equivalent to
an after tax yield of 2.97% on your $10,000. This illustrates that what appeared to be a simple and attractive
investment in a term deposit was not actually a good investment in terms of yield.

4.24% VS 2.97%

Share Options
Once you have figured out shares, there are various ways you can tweak and tailor your investments. One
of the most common methods is to use options, which can do a number of things, such as reduce the risk,
reduce the initial money you put in, limiting the
trading range – depending on the type of option
you hold. When trading shares, you usually want them to rise, however with options, you can bet many
things, including if the share price rises, if the share price falls, if the share price remains flat or if the share
price stays within a specific range.

There are two main types of Options

 1. Equity Options (also known as Exchange Traded Options)which is the right, but not the obligation
to buy (in the case of a call) or sell (in the case of a put) shares of the underlying security at a
specified price (the strike price) on or before a given date (expiration day). After this given date, the
option ceases to exist. The seller of an option is in turn, obligated to execute a trade on the shares
with the buyer of the option at the specified price upon the buyer's request (ASX).
2. Index Options give you exposure to the securities comprising a share market index. They offer you
similar flexibility to that provided by options over individual stocks, while allowing you to trade a
view on the market as a whole, or on the market sector covered by the particular index. Whereas
the value of a share option varies according to movements in the value of the underlying shares, an
index option varies according to movements in the underlying index (ASX).

You can either buy put options or call options. Put options are the option to sell at a specific price, at or
before the expiration date. The opposite of this is the call option which is an option to buy at a specific price,
at or before the expiration date. On the other end of this are the “writers” of these options, these are the
people who price these options and sell them to investors. This means, if you have the option to buy and
sell, then they are obliged to buy and sell if you wish to transact. So if you hold a call option and decide to
execute, then the writer is obliged to sell.

Why Options?

They can:

• Protect your shares from price volatility, in particular a fall in price

• Use your insight to earn income against shares you hold, or are looking to buy
• Increase your returns through leverage
• Diversify your portfolio

For more info on options, have a look at the ASX website.