Introduction to the stockmarket

Mark McIlroy Blue Sky Technology 2013 www.blueskytechnology.com.au

1. Investing in the stockmarket The stockmarket is one o the our ma!or asset classes or in"estment# the others being $ro$erty# i%ed interest and cash. It ty$ically has a higher long term return that any o the other ma!or asset classes# although this is at the cost o higher "olatility in $rices. In"esting in the stockmarket in"ol"es buying shares. &wning shares means that you are a shareholder and one o the owners o a com$any. 'ou are entitled to a share o the $ro its that a com$any generates and a share o the assets i it is wound u$. Share $rices range rom a ew cents $er share u$ to se"eral hundred dollars $er share. Share $rices cannot be directly com$ared to each other but are com$ared using ratios such as the () ratio and *i"idend 'ield. In"esting in the stockmarket is or long term returns. The market has returned around 13+ $er annum o"er the last 100 years which is higher than any other ma!or asset class. ,owe"er $rices can all by -+ in a day and u$ to -0+ o"er a year. 2

. share $rice can all to /ero but you cannot be le t owing more money than you $aid or the share 0known as 1imited 1iability2.

2. Dividends *i"idends are one o the main reasons or in"esting in the stockmarket. 3hen a com$any makes a $ro it# as most do# it may $ay out some o the $ro it to shareholders as a di"idend. This is recei"ed as a cash $ayment by the shareholder. *i"idends are usually $aid twice a year. The 4di"idend yield5 is the $ercentage return at the current share $rice. *i"idend yields are ty$ically 2+ to 3+ but may be as high as -+. This is the annual di"idend di"ided by the share $rice and is similar to the rate o interest on a bank account. Stable com$anies with low earnings growth generally $ay good di"idends. ,igh growth com$anies may $ay little or no di"idends. *i"idends can be in"ested in new shares instead o being recei"ed in cash through a com$any5s *i"idend 6ein"estment (lan. 3

,owe"er this can make ta% calculations com$le% when it comes time to sell the shares.

3. Franking In .ustralia# the go"ernment has introduced a system known as *i"idend Im$utation or 7ranking. This means that in"estors recei"e a ta% credit on di"idends recei"ed e8ual to the ta% that the com$any has $aid. The current com$any ta% rate is 30+. This means that di"idends recei"e a ta% credit o 30+# i.e. i your margin ta% rate is 30+ there is no ta% to $ay on the di"idends. I your ta% rate is lower that 30+ you recei"e a re und in cash rom the ta% o ice or the di erence# and i it is more than 30+ you only $ay the e%cess o"er 30+. This is or 7ully 7ranked di"idends# some com$anies only $ay $artly ranked or un ranked di"idends.

4. Economics )conomics is the study o growth and $roduction in the economy o a country. The most im$ortant economic indicator is 9*( or 9ross *omestic (roduct. 9*( measures the total $roduction o a country5s economy.

This is usually re$orted as the growth o"er the $re"ious year# in real terms 0i.e. a ter in lation2. 9*( growth is ty$ically 3+ or de"elo$ed economies and u$ to ;+ or emerging markets. The rate o 9*( growth has an im$ortant im$act on com$any $ro its and interest rates. 3hen growth is high# the central bank will raise interest rates to slow the economy and $re"ent the outbreak o in lation. 3hen growth is low# the central bank lowers interest rates to stimulate growth and $re"ent a recession. . recession is de ined as two 8uarters o negati"e growth.

5. Diversification It is "ery im$ortant when in"esting in shares to s$read your money between a number o di erent in"estments. It takes about 1- com$anies to reduce your risk to the risk o the o"erall market. This is most easily achie"ed by in"esting in a managed und.

6. Managed funds 3hen in"esting in a managed und# your unds are $ooled with other in"estor5s money and managed by $ro essional managers. In"esting in managed unds is the most e ecti"e way to reduce your risk to the risk o the o"erall market and a"oid 4stock s$eci ic5 risk. ,owe"er the disad"antage is that there are ees to $ay to the managers and this may also include commissions to inancial ad"isors. Managed unds ty$ically hold in"estments in 30 to 100 com$anies.

7. Inde es .n inde% is a way o measuring the o"erall le"el o share $rices. 7amous inde%es are the *ow <ones and S=( -00 inde%es in the >nited States and the .ll &rdinaries Inde% in .ustralia. The inde% is an a"erage le"el o share $rices in se"eral hundred com$anies. The le"el o inde% "alues is widely 8uoted in the $ress.

!. Inde Funds .n inde% und is a und that does not attem$t to beat the o"erall market but sim$ly $ro"ide the o"erall market return. The inde% und attem$ts to match the return on an inde% with is a measure o the o"erall stockmarket return. The ees o inde% unds can be lower than acti"ely managed unds. This can make a big di erence to your o"erall return o"er the long term. The a ect o com$ounding returns means that a small di erence in the annual return can translate into a large di erence in the inal "alue o an in"estment.

". Financia# $na#%sis 7inancial .nalysis o com$anies generally ocuses on the inancial statements# which are released twice a year. The balance sheet records all the assets and liabilities 0debts and other owings2 at the balance date. The inancial statements are $re$ared according to national and international accounting standards to ensure that they can be com$ared between com$anies.

. high le"el o debt is a warning sign that the com$any is risky howe"er this does not always become ob"ious until it is too late. The (ro it and 1oss statement records all the income and e%$enses or the $eriod.

1&. 'atios .nalysis o com$anies generally uses ratios. The most im$ortant ratio is the (rice@)arnings ratio. This is the ratio o the share $rice to the com$any5s earnings. The () ratios is generally around 1- but may be as high as -0 or high growth com$anies. The () le"el o the o"erall market is also re$orted in the $ress. This is an e%tremely im$ortant indicator o the le"el o the o"erall market. 'ou should a"oid in"esting in the stockmarket when the () is at a high le"el. This is a sign that the market is o"er"alued and could be due or a crash. &ther ratios include the (AT.# the (rice to Aet Tangible .ssets ratio. This com$ares the share $rice to the assets o the com$any. The measure o assets e%cludes intangible assets such as goodwill and media mastheads.

11. (hen to avoid the market The stockmarket is sub!ect to regular alls and e"en occasional crashes. 'ou can take a long term "iew o the market and in"est during the highs and the lows. ,owe"er# i you ha"e a lum$ sum to in"est you should consider the o"erall le"el o the stockmarket be ore making an in"estment. . ter se"eral years o strong rises the market may become o"er"alued. This is an indication that a all is due. The o"erall le"el o the market is best measured using the market () ratio. This is widely re$orted in the $ress in economics articles.

12. )ro*ert% trusts .s well as shares in com$anies running businesses you can also buy units in in"estment trusts on the stock e%change. These most commonly in"est in $ro$erty. 'our unds are $ooled with other in"estors and used to buy $ro$erties. C

This method is an e ecti"e way o in"esting in $ro$erties although you should be care ul that the und manager has not borrowed too much as this can lead to "olatile $er ormance and losses.

13. EF+s )7Ts or )%change Traded 7unds are a modern de"elo$ment in the market. These are in"estment unds with the units traded on a stock e%change. The ees are ty$ically lower than other managed unds. The und may be an inde% und or may be acti"ely managed.

14. ,harting Dharting is one orm o in"estment analysis that you will read about in the inancial $ress. Dharting in"ol"es $roducing charts o share $rices and looking or $atterns in the $rices. The academic research suggests that charting is not e ecti"e and that undamental research is more e ecti"e. ,owe"er charting is widely used es$ecially or commodities and oreign e%change.

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15. -a#ue and gro.th investing (ro essional unds managers generally manage their $ort olios according to an in"estment 4style5. The academic research suggests that 4"alue5 com$anies out$er orm other com$anies o"er the long term. These are share $rices with low $rice@to@AT. and () ratios. &ther managers look or com$anies with strong growth $otential and in"est in 4growth5 com$anies.

16. /*ening an account To buy shares you will need to o$en an account with a stock broker. This is generally ree. Brokerage rates ha"e come down o"er recent years and it is $ossible to trade rom E2- $er trade. Some brokers o$erate $redominantly online and also through call centers.

17. Margin 0ending

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I you want to borrow money to in"est in shares this can increase the long@term returns but also increases the risk . margin loan is a"ailable rom stockbrokers or u$ to ;0+ o the "alue o the e%isting shares held. This can tri$le the si/e o your in"estments. The shares are held by the broker as security or the loan howe"er you continue to recei"e all di"idends. I the "alue o the shares alls# additional cash must be $ut into the loan or some o the shares are sold. This is known as a 4margin call.5

1!. +he Efficient Market 1%*othesis The ) icient Market ,y$othesis is an academic theory relating to the stockmarket. This theory states that share $rices already ha"e all known current in ormation 4$riced in5 to their share $rice. This means that uture mo"es are random and that it is im$ossible to out$er orm the o"erall market by selecting indi"idual com$anies or in"estment. There is considerable academic e"idence that the ) icient Market ,y$othesis is correct. This has serious im$lications or in"estors.

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It suggests that inde% unds are the best in"estment as they o er the o"erall market return with lower ees than acti"ely managed unds.

1". ,onc#usion &"erall in"estment in the stock market is one o the best long@term in"estments that an in"estor can make. It is $articularly suitable or accumulating retirement sa"ings as they will be in"ested or a long $eriod o time and can ride out the u$s and downs o the market. *i"ersi ication is im$ortant and this can best be achie"ed using managed unds and inde% unds. The best in"estments are inde% unds as these deli"er the o"erall market return with lower ees.

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