Basics of buying shares : Lesson 2

In lesson one I told you that the best place to start looking for shares to buy was the Fund Fact sheets of the best Unit Trust Portfolio Managers in the country. On these Fact Sheets they publish the top 10 shares held in the fund.

Why is this a good place to start? Because there are two very important things to consider before buying a share:

1. Is the company going to be profitable going forward?
2. Is it a good price to pay for the company?

To answer the first question you need to understand the company very well. You have to talk to management to understand where they want to take the company. You have to analyze the financial statements to understand the future potential and the risks involved. To do this you have to spend a lot of time and you have to be bright.

Portfolio managers employ the best analysts to do this job. They spend their days dissecting the companies and then make recommendations to the manager of the fund. The fund manager, with years of experience make the final decision based on his/her fund mandate.

Why would I try to do all of this work with my limited time and skill, if I can just go and get the results from their fact sheets?! So if there is consensus between the top fund managers as to which companies will be profitable going forward, the chances of if happening is pretty good!

The second question is not as easy to answer. By the time you see the shares on the fact sheets, the share price might have gone up already, making it less of a good investment. The price you pay will determine the success of your investment.

To summarize, finding a name of a share on a fact sheet makes it a good share, but not necessarily at the right price. 

Below is a summary of the top 11 shares from my top 5 rated fund managers. Each share appears on the list of at least 2 of the fund managers.

	Price	F P/E	D/Y	1 yr	30day
Anglo American	264	15	2.89%	-3.60%	18.00%
Sasol	530	10	3.57%	36.70%	2.80%
BHP	322	13	3.49%	6.10%	0.50%
SAB	491	20	2.00%	9.80%	-8.00%
BAT	527	16	3.62%	16.30%	-5.10%
Standard	115	11	4.11%	-2.60%	-9.40%
Richemont	106	51	1.04%	46.70%	4.70%
Old Mutual	32	12	3.29%	21.60%	-4.90%
Investec	75	14	3.72%	10.60%	-1.10%
MTN	199	15	4.35%	13.30%	-5.40%
Naspers	1138	45	0.34%	87.80%	3.40%
	52 High	52 Low	Median	Fall
Anglo American	281	185	233	-13%
Sasol	558	369	464	-14%
BHP	338	247	293	-10%
SAB	550	430	490	0%
BAT	571	454	513	-3%
Standard	130	105	118	2%
Richemont	108	67	88	-21%
Old Mutual	35	27	31	-4%
Investec	78	60	69	-8%
MTN	217	158	188	-6%
Naspers	1178	556	867	-31%

From this list I can make the following assumptions:

• They are all quality companies
• They will still be around 10 years from now

The next question is "do they still offer value at the current price?"

To answer this question I look at the information provided next to each one of the shares. I got the information from my online trading platform. Most of the stockbrokers with online trading facilities like Nedbank Online Trading, PSG online, Sanlam I-Trade etc. will provide you with this basic info.

Look at the list. Do you also have these shares on your list? Which of these shares do you think offer value? Would you buy them now? That is what you have to do before I get to the Third lesson. To explain the different columns:

• Price: The current trading price
• F P/E: the forward Price Earnings ratio
• D/Y: Dividend Yield
• 1yr: the price movement over the last 12 months
• 30 days: the price movement over the last 30 days
• 52 High: the highest price over the last 52 weeks
• 52 Low: the lowest price over the last 52 weeks
• Median: the price between the high and the low
• Fall: the percentage the current price can fall to get to the median price

I will tell you which of these shares I would buy today and why in Lesson 3.

Basics of buying shares: lesson 1

How do I begin????? This is a question that gets asked a lot and should be music to the ears of a parent of a young child. I will tell you how I began building my share portfolio and you can use it and improve on it.

The most important thing is to remember that it is like taking up any new challenge. It takes time and commitment! You will feel clumsy at first but the learning curve is steep and pretty soon you will have the basics figured out. Here are the steps:

• Select 20 shares you want to watch. You DO NOT buy them yet!
• Research the chosen shares. (will take weeks if not months)
• Open an account with an Online Stockbroker.
• Run a dummy portfolio for a month.
• Start buying the shares you are sure offer good value.

Things to remember

• Some of your shares will go down before they go up.
• Never get emotional about gains or losses.
• Invest in shares that you want to be a part owner of for the longer term, do not speculate.
• Do not buy and sell often, do not try and time the market. When you believe that a solid company can be bought at a good price, buy it and never sell it. (for now)
• Do not borrow money to invest in shares. This is a long term commitment and you should NEVER be forced to sell.
• Building your own share portfolio keeps you updated with world finance in general. It becomes a hobby that will not only be something you can carry on doing till the day you die, but also something that can become your main source of income and something you can do anywhere in the world with almost no capital outlay!

Think back on something that you wanted to take up 20 years ago but never did. If you did, how good at it would you have been by now?! I always wanted to play guitar and took it up twice but never persevered. If I did I would have been able to play by now and would have been able to do something that would have added a lot of value to my life. 

...........a lot of "would haves"!!!!!

I will take you through the process over the coming weeks and months but to get the show on the road the following homework:

• Download the Equity fund fact sheets of the top 5 unit trust fund managers (called "mutual funds" in the USA) from their web pages and create a spreadsheet of their top 10 share holdings that they have to list on the fact sheet. In SA the fund managers that I rate are Allan Gray, Foord, Coronation, PSG and Prudential.
• Make sure it is the Equity Fund and not the balanced, income, bond, flex etc. (Prudential calls the one I like the Dividend Maximiser Fund).
• Also ensure it is the local equity fund. If you live in SA then go to the "LOCAL EQUITY" section.

This is the first step, go for it!!

Thinking about passive income

When I was in 5th grade I had my first introduction to the stock market. One of my talented friends entered a competition where he had to write a song for the provincial Rugby team and won. He got some money and then did something nobody understood, he bought shares!

During his articles at an accounting firm he met a wealthy businessman and they started a property development company with a market cap of R11,5 billion Rand as I write this.

Why do I share this flashback with you? Because when he won the money, every single one of his friends (aged 10) could only think of the pocket knife he promised to buy every one of us. The way we think about life determines how we participate in it.

There are 4 main ways to participate in the income generating part of life and they are:

• Go work for somebody else (employee)
• Start your own business (employer)
• Buy an established business (owner)
• Buy a share in a business (investor)

Without making things to complex I want to put forward that the last one is the best one. The following reasons can be given:

• I do not have to work according to the rules of my boss.
• I do not have to worry about getting fired.
• I do not have to worry about the problems of my employees.
• I do not have to be at work 24/7 to ensure that nobody destroys my business.
• All my money is not tied up in one venture.
• I make money as I sleep.
• I can do my work from anywhere in the world.
• I do not have to worry about the politics of the country my business is in.
• I do not have to go through a lengthy process of selling my business or looking for another job.

The list goes on and on and on........

The beauty of buying a share in a business (buying a share on the stock market), is that you make friends with two very powerful forces:

• Passive income (dividends)
• Power of compounding growth

On top of that you can choose the best managers in the world in businesses that have proven themselves over decades!

I bought my first share when I was about 16 years old. It was a stock tip from a friend and it was a Gold Mining company called Jules. I made what seemed like a mountain of money on that share but for some reason the investment bug didn't bite. It was only when my love affair with working 12 hour days for somebody else faded that I "discovered" investing again.

What I am getting at is that anybody can start investing. You do not need to make it your job but it will provide you with the ability to generate the best returns with the money that you do generate from doing whatever you love doing and at the end of the day it can start taking care of you.

There are two very important things to remember when it comes to investing:

• The younger you start the better. The biggest secret to investing is to understand what you are investing in. It takes a long time to understand a company. To know what a good price is to buy it at and when it should be sold. You have to read all the news and listen to all the comments about it. You have to watch it for a long time before you commit to it.
• Only buy a share in a company if it is a company that you would like to be a part owner of for a long time. Sometimes it takes a long time for value to unlock. Speculating is fun but nothing else.

When I was growing up the mantra was "get educated so you can at least fall back on something, even if you don't like it". Unfortunately this is the truth, and for the majority of people the way it will be. The lucky ones are the ones that have a passion for something and can make a living from doing it. 

I say that if you can develop an interest in investing, you will never have to worry about living too long. Your passive income and the knowledge of investing in the right shares will provide you with financial independence or at least provide a healthy supplement to your normal income.

Beware!!!! Once you leave home and start buying those nice lifestyle assets, you might just never get out of the debt trap and having spare cash to invest becomes impossible! You have to get going with your pocket money while you still live at home! Like Warren Buffett said, very early on he realized that for every Dollar he spent, he could have made ten if he invested it!

TIP: get your children to read his books or read it to them. It is easy and very entertaining.

What to do with new money?

It was a spectacular 2013 and I need not say more on that. The year before, 2012 was even better so I cannot see SA equities delivering the same results in 2014 although some counters (Resources) had a dismal 2013 and could bounce if China starts growing again. The USA had a 27% (in $) return, also following a good 2012 and with the Rand depreciating 23% in 2013 SA investors smiled all the way to the bank.

Bonds will remain under pressure with interest rates going up rather than down so to answer the question of where to invest additional funds in 2014, I will say 50% in International Equities and 50% in SA equities for longer term.

Reason: Even if we get a very low 2014 for equities, I prefer not to time the market and regarding the international side, Developed markets still offer better value for money than SA and even though the Rand should strengthen against the $, there are no guarantees.

If my gut feeling is right, any Equity investment made by a SA investor will not perform much better than cash in 2014 but I have been wrong too many times to trust my own short term predictions and would rather just follow sound investment principals and get the money into the right place for the longer term growth prospects.

Some very unpredictable things can happen in 2014:

• The reaction to election results in South Africa
• The striking miners in South Africa
• The US tapering and debt ceiling handling
• China growth?
• Europe back into recession?

The good thing is that the US seems to be recovering well. That should at least stabilise many of the potential surprises.

Markets in 2014

The past week was an indication of what I expect for 2014. The South African share market came down by 4% and the Rand weakened by 4% while the Dow Jones in the US reached an all-time high. The SA market and Rand then bounced back a bit but the soft underbelly of our economy has exposed itself to what can be expected in 2014.

2013 has been another tremendous year for equities! SA is up 20% and the USA also. This follows a 2012 of 26% in SA! My prediction is for a volatile but flat 2014 in SA but good returns in the USA and Europe. There are 2 things that will dominate the markets in 2014 and they are:

·       USA tapering and
·       Growth in China

Fed Tapering is the process by which the central bank in the USA decreases the amount of money they pump into the economy. Why is this bad? Because it is like putting only a little petrol in your car instead of filling her up and still having to drive the same distance. You will naturally take your foot off the accelerator and if you are not over the steep mountain pass, you might just run out of gas before the downhill.

 
Tapering will only happen when the economy in the USA is strong enough to support itself and although short term traders in the market will sell some of their shares, the longer term outlook for global shares will be positive. Unfortunately for South Africa, this will make risk free investments in the USA more attractive (long bond yields in USA will go up), and the result will be the selling of SA shares and bonds to take back to the USA.
 
The double whammy for South African investors will be the further weakening of the Rand or at best little potential for Rand strength. Given the inability of our supreme leader to follow the good advice of his ministers like Pravin and Trevor, who understand that our trading partners and the people with money and power follow a capitalist approach, he still dwells in an African Tribal mindset where a R200 mil homestead and friends, rather than competent individuals in strategic government positions dominates his thinking.

 As for other asset classes like cash and bonds you will once again cry your eyes out like you did this year! Cash gave you 5% and Bonds 1%. Listed Property will follow bonds down initially but medium term I would start looking at allocating some money here.

 Once again we will wait with bated breath for China to come and save our commodities driven economy.  If Chine can manage a better GDP growth, say above 8%, our commodities will benefit a lot. 2013 saw another year where the shares in our market performed out of sync:

Industrials          30%

Financials           19%
Resources          2%        

So switching from overvalued financials and Industrials into resources will be a play lots of investors contemplate. All in all you have to stick to the sound investing principals of holding cash for 2-3 year expenses but committing longer term money to shares, some local but the majority overseas.

Financial Discipline

If you should receive all the money you would ever earn at birth, how would you spend it?

So let us say that your budget is R20 000 per month for 90 years. That will give you a lump sum at birth of R21 600 000. Now anybody receiving this amount of money at birth would probably die on the spot. But let us see what it really means.

Point number 1: With an inflation rate of 6% per annum, R21 600 000 today will buy you only R114 000 worth of goods in 90 years’ time! So you will have to earn a return on this amount of at least 6% to preserve the buying power of the money. This translates into an investment OTHER than a bank account because interest after tax will give you LESS than inflation.

Point number 2: There will be times where you will have to spend way more than R20 000 in a month to support your lifestyle for example when you buy a car or a house. The implication is that you will have to carry some of the monthly allowance over to an investment to prepare for those occasions. You will also have to determine how much you have to save every month to provide for a specific car or house BEFORE you buy it.

Point number 3: You will soon realize that as you grow older, your financial needs increases due to education, health and comfort reasons. When you are young the doctor can wait. You can sleep in a tent and only need to eat something to satisfy your hunger. In other words, you do not need the fancy stuff. This will give you the opportunity to make use of the power of compounding where if you leave the money in your investment, you will earn interest on the interest! This is where most people will fall into the trap of BUYING more than they need for whatever crazy reason!

Lastly, you do not know how old you are going to get so you will have to evaluate your financial plan continuously to ensure that you do not dip into your reserves to such an extent that you will run out of capital before you die.

THE SAME RULES APPLY for all of us earning our income as we go on and not in one single lump sum!

In summary:

·        Inflation will be your biggest enemy.

·        Provide for the big ticket items and make sure you can afford them.

·        Don’t waste money just because you have it. The lean years will come.

·        Formulate a financial plan early on and evaluate it regularly.

Markets for first 6 months of 2013

If you have been following the investment markets over the last 6 months you would have noticed 5 very distinct things being:

1.      The South African share market has been very volatile. It has gained 7% at its highest point and lost almost 4% at its lowest point giving it an 11% spread from peak to trough.

2.      The Rand has depreciated 21% against the US$, moving from R8.50 to touch R10.30 at one point.

3.      The US market has outperformed the SA market by more than 16% in US$ terms. Developed markets in general has outperformed emerging markets year to date.

4.      Listed Property and Bonds have been struggling.

5.      Gold, Platinum, Silver and most other metals have been taking a beating.

Looking at the under performing South African market one can name at least two culprits and they are the slowing Chinese economy and the lack of political talent. South Africa is very dependent on countries like China buying our mineral wealth and when there is a slowdown in the demand for our commodities, the price will fall. This will give rise to our imports exceeding our exports which will increase our current account deficit, which will be exacerbated by the weakening Rand due to foreigners taking their money out of South Africa to invest in the rising bond yields in the USA.

Another problem that faces the Rand is the inability of our government to manage the wage disputes and general well being of our economy which gives rise to an increase in the budget deficit, the downgrading of South Africa’s credit rating and ultimately the loss of confidence by international investors.

Looking at the rest of the world we can see a very confused investor public. Whenever there is good news about the growth in the US economy, the market goes down instead of up. This in mainly due to the fear of investors that the US central bank will start closing the tap on free cash. The signs of growth in the US is good news and that is why we have seen the share market outperforming the emerging markets like South Africa. It is about time for the shares in the US to gain some traction if you consider the poor performance for the last decade up to 2010. The US market has outperformed the Emerging Economies by 22% in $ terms year to date!

I am not too worried about the short term volatility in the markets and have been avoiding exposure to Gold, Listed property and Bonds for a while now due to the clear indications that they are either over valued or on the wrong side of the interest rate cycle. I have been telling my clients to increase their exposure to offshore shares because of the under performance of that sector and the strength of the rand over the last couple of years.

I am worried about the situation in South Africa and do not believe that the situation will be resolved over the short/medium term. Investing in South Africa will remain a higher risk investment than some of the developed economies and has recently increased that investment risk. There are two things one should do to mitigate this increased risk and they are:

1.      Ensure a well-diversified international portfolio. Focus on the USA

2.      Be very specific when selecting South African shares to invest in.