JERRY MONONELA - Introduction to Stock Markets

Share Trading Basics

 

Introduction:

Owning shares is one of the greatest tools to wealth creation you can find. Shares, apart from owning fixed property,

should form the cornerstone of any investment portfolio. You do however need a firm understanding of the stock market

basics before dipping your toes (and your money) into the sea of opportunity which is the stock market.

It is like having a business but not having to show up at work.

The interest of the average Joe has grown exponentially in the last couple of years. This can be attributed to the flow

(mostly freely accessible ) of information on economic affairs and stock specific

news. What was once a toy of the wealthy has now turned into the vehicle of choice for wealth creation. Technological

advances has put the opportunity of trading the stock markets at your fingertips wherever you might be.

 

What are shares?

A share is simply what it’s name suggests - you share in the ownership of a company. It represents a claim on the

company’s assets and earnings. It is sometimes called stock, equity or shares but they all mean the same thing.

Holding a company’s shares means that you are one of the many owners (shareholders) of a company and have claim to

everything it owns. This claim is usually very small but you are entitled to your portion and hold your voting rights.

Shares were held in certificate form but electronically held shares have become the norm. All South African shares are

held by a CSDP (Central Securities Deposit Participant) in electronic format.

This makes it far easier to trade the shares at the click of a mouse button. Share certificates had to be taken to the broker and then to the transfer secretaries which made it and arduous task.

Being a shareholder does not give you title to the day-to-day running of the business. Your extent to which you have a say

in the company is limited to one vote per share at annual meetings where you vote for the board of directors. Being a

shareholder of South African Breweries does not entitle you to walking into their plant in Rosslyn and helping yourself to

a couple of beers or calling the Chief Executive Officer to share your ideas on how they should run the company.

Large institutional shareholders have the biggest say in the appointment of management and they have to increase the value of the company for shareholders.

Profits are shared in the form of dividends. Your claim on the assets is only relevant should the company go bankrupt.

An important feature of owning shares is your limited liability should the company not be able to pay it’s debt. No matter

what happens, the maximum value you can lose is the value of your investment in that company. Your personal assets are never under threat should the company go bankrupt.

 

Company Funding- Debt vs. Equity.

Companies raise capital by debt financing (loan from the bank or issuing a bond) or equity financing ( selling part by issuing shares.

Issuing stock is advantageous as the company does not have to pay back the money or make interest payments along the way. The first issue of stock by a private company is called the initial public offering (IPO).

When you buy a debt investment such as a bond , you are guaranteed a return of your capital along with interest payments. By buying an equity investment you you assume the risk of the company not being successful. If the company goes bang you only get paid after the banks and the bond holders have been paid. Shareholders earn a lot if the company is successful but stand to lose their entire investment should the company fail.

There are no guarantees when it comes to individual stocks. Some companies pay dividends , but others may not. There is no obligation to pay dividends. You make money by the appreciation of the stock price.

Although risk might sound negative , there is a bright side. Taking on risk demands higher returns. That is why shares outperform bonds or bank savings.

 

Types of shares.

There are two types of shares: common stock and preferred stock.

Common stock

When people talk about shares they usually refer to this type. Common shares represent ownership in a company and a claim (dividends) on a portion of the profits. Investors get one vote per share to elect board members who oversee the major decisions made by management. Common shares hold the biggest risk as the holders of this asset class will not

receive money until the creditors, bondholders and preferred shareholders are paid.

Preferred stock

Investors in preferred shares are normally guaranteed a fixed dividend but without the same voting rights of common shares. These shares are also callable and this means the company can buy back these shares at any time and for any

reason (mostly at a premium).

Different classes of stock

Companies can customize different classes of shares in any way they wish so as to give the voting power to a different group. One group may have 10 votes per share while another class will have one vote per share. Normally Class A or Class B stock etc.

How are shares traded?

Shares are traded on exchanges. Some exchanges are physical trading floors where traders seem to be running around

waving and speaking sign language in addition to loud screaming. This looks crazy but is actually quite orderly. The other type of exchange is virtual, composed of a network of computers where trades are executed electronically. This form of

trading is far more transparent than floor trading. The JSE closed it’s open outcry floor in 1997 and everything is now traded through a network of computers linking the exchange to the JSE’s virtual trading pits.

Exchanges facilitate the exchange of securities between buyers and sellers, reducing the risks of investment. There is a

primary market where shares are created (by means of an Initial Public Offering) while in the secondary market , investors trade previously-issued securities without the involvement of the issuing-companies.

The Johannesburg Stock Exchange.

About the Main Board

In 1886, the discovery of gold on the Witwatersrand led to a boom in mining and financial companies and a stock exchange was soon needed. And so began the Johannesburg Stock Exchange’s Main Board.

 The JSE holds a treasured position as one of the top 20 exchanges in the world in terms of market capitalisation. The majority of this market capitalisation is based on the companies listed on the Main Board and the JSE’s top 40 stocks are also listed here.

These stocks are highly regarded by both local and international investors.

The Main Board houses the same sectors grouped according to the London Stock Exchanges XXXX. Dual listings are actively encouraged and are possible on all boards of the JSE.

A list of all Main Board companies can be found here.

Listing benefits Access to capital for growth: listing gives you the opportunity to raise capital to fund acquisitions as well as growth.

Boost your profile: listing generally heightens your company’s public profile with customers, suppliers, the media and investors. As a result more business opportunities become available to you.

Create value and liquidity for shareholders: because your company’s value is independently assessed, shareholders can realise their investment, liquidity is stimulated and your shareholder base may be broadened.

A listing allows you to facilitate broad-based black economic empowerment (BEE) deals, a prerequisite to effective corporate citizenship in South Africa.

You may offer share incentives to employees to encourage commitment and improve the quality of recruits.

Why the JSE?

The JSE is well positioned to help you leverage your listing to its maximum. In addition to the benefits above, listing on the JSE allows you to:

Enjoy local analyst coverage as well as high media interest.

Attract international investors who are easily able to trade in JSE-listed shares without any restrictions.

Trade your shares securely and efficiently on JSE TradElect™, the London Stock Exchange’s trading system.

Be eligible for inclusion in the FTSE/JSE Africa Index Series, thus creating additional exposure for your company both locally and internationally.

Marketing your business to investors with the assistance of the JSE Business Development team.

·         Dual listings

·         Dual listings brochure

 

company on the JSE gives you the opportunity to:

Tap into local knowledge, skills and interest.

Use your listing as a springboard into the rest of Africa.

Access deep pools of capital relative to other African markets.

Use your shares as local currency for transactions.

Increase and diversify your company’s pool of liquidity

Facilitate compliance with South African government charters on broad-based black economic empowerment.

Is listing for you?

The decision to list your company needs to be made once you have realistically assessed your company, its management, resources, stage of development, long-term strategy, goals and future prospects. You would also need to consider the timing of a listing in terms of market conditions and where your business is at that point in time.

There are many specific requirements that you need to meet which are in the JSE Listing Requirements. These can be accessed on their website. We have three markets on which you could list: the Main Board, the Africa Board and the

Alternative Exchange (AltX). The decision to list on either market depends on factors like the size of your company, your funding requirements and what you would like to achieve with your listing. Listing may be just what you need to take your business to the next level. A typical main board listing requires 300 different shareholders with a spread of at least 20% and a 3 year proven profit before tax of R 8 million Rand.

What makes Share prices change?

Share prices change everyday compliments of market forces of supply and demand. Participants have different perceptions of a company’s potential earnings and are therefor prepared to pay different prices for a share. If more people want to buy a share(demand) than sell it (supply), then the price moves up. Understanding supply and demand is easy. What makes trading stock difficult is understanding what makes people like a certain share and dislike another.

Every investor has his own ideas and strategies. Some are just outright punters.

The price of a share is determined by what investors perceive it to be worth. The value of a company is it’s market capitalization which is simply calculated by share price multiplied by the amount of stock in free float. Matters are complicated by the price of a share which reflects the growth that investors expect in the future.

The most important factor in valuating a company is it’s earnings. Earnings are the profit a company makes. Without profit it can’t survive. Companies are required to report their earnings and the market watches these reports to determine future value. If the earnings surprise share prices jump and conversly when they dissapoint the stock prices fall.

Sentiment is a very important driver of price as was evident in the dotcom bubble. Tech companies saw their valuations shoot through the roof despite them not making a cent yet. These valuations did not hold and their values shrunk to a

fraction of the highest prices they achieved. There are numerous variables that influence price and investors are developing more and more to determine valuations. You might have heard of like price/ earnings ratio, while others have obscure names like Chaikin oscillator or moving average convergence divergence. So why do prices change? Nobody really knows but we know for certain that they are volatile and that creates opportunity. At the most fundamental level , supply and demand in the market determines share price.

- price times numberof shares in free float is the value of the company. Comparing just the price is meaningless.

- earnings affects investor’s valuation but other indicators are also used to predict the price.

- there are many theories that explain share price movement. There is however no one theory that can explain

everything.

Buying Shares

How do you buy and sell shares. You luckily don’t have to go into a trading pit and yell your order. There are two main

ways to purchase shares.

Using a broker

There are two types of brokers : full-service who supposedly offer expert advise and charge higher fees and discount brokers who execute without any add-ons.

With the advent of the internet trading platform most brokerage houses have changed to the latter. Anyone can now afford to invest in the market.

DRIPs

Dividend reinvestment plans allow investors to purchase stock directly from the company by reinvesting their dividends.

How to read a share quote

Any financial newspaper should have the following tables giving you share price info:

This clip was taken from US newspaper so quoted in Dollar but SA shares are quoted in SA cents per share.

Columns 1 & 2: 52-Week High and Low - These are the highest and lowest prices at which a stock has traded over the previous 52 weeks (one year). This typically does not include the previous day's trading.

Column 3: Company Name & Type of Stock - This column lists the name of the company. If there are no special symbols or letters following the name, it is common shares. Different symbols imply different classes of shares. For example, "pf" means the shares are prefs.

Column 4: Ticker Symbol - This is the unique alphabetic name which identifies the stock. If you watch financial TV, you have seen the ticker tape move across the screen at the bottom, quoting the latest prices alongside this symbol. If you are looking for stock quotes online, you always search for a company by the ticker symbol. If you don't know what a particular company's ticker is you can search for it at http://www.jse.co.za/How-To-List-A-Company/Main-Board/Main-Board-Listed-companies.aspx

Column 5: Dividend Per Share - This indicates the annual dividend payment per share. If this space is blank, the company does not currently pay out dividends.

Column 6: Dividend Yield - The percentage return on the dividend. Calculated as annual dividends per share divided by price per share.

Column 7: Price/Earnings Ratio - This is calculated by dividing the current stock price by earnings per share from the last four quarters. For more detail on how to interpret this, see the P/E Ratio explanation in later chapters.

Column 8: Trading Volume - This figure shows the total number of shares traded for the day, listed in thousands. To get the actual number traded, add "000" to the end of the number listed.

Column 9 & 10: Day High and Low - This indicates the price range at which the stock has traded at throughout the day.

In other words, these are the maximum and the minimum prices that people have paid for the stock.

Column 11: Close - The close is the last trading price recorded when the market closed on the day. If the closing price is up or down more than 5% than the previous day's close, the entire listing for that stock is bold-faced. Keep in mind, you are not guaranteed to get this price if you buy the stock the next day because the price is constantly changing (even after

the exchange is closed for the day). The close is merely an indicator of past performance and except in extreme circumstances serves as a ballpark of what you should expect to pay.

Column 12: Net Change - This is the cents value change in the stock price from the previous day's closing price. When you hear about a stock being "up for the day," it means the net change was positive.

You can also get stock quotes (delayed) from websites like www.jse.co.za or www.moneyweb.co.za

A bid is the price someone is prepared to pay and the offer(ask) price the price at which someone is prepared to sell.

When these two meet they transact and a deal is created.

Bulls and bears.

A bull market is when everything in the economy is great, people are finding jobs, gross domestic product (GDP) is growing and share prices are in a rising trend. Picking shares to buy in a bull trend is relatively easy as most go higher.

These strong bulls mostly lead to overvalued stocks which is dangerous to the investor. Greed invariably feeds the bulls to just keep on paying any price. If a person is always optimistic about share prices risign they are called bullish or a bull.

A bear market is the opposite of a bull market. Times when the economy is bad and recession looming are refered to as bear markets. A person with a pessimistic point of view or belief that stock prices will come down rapidly is refered to as bearish or a bear.

Chickens are what the name implies: a person who is so risk averse that they don’t commit any money to the market and rather invest in money-market instruments.

Pigs are highrisk takers and by on hot tips etc. fueled by their greed. Proffesional traders love pigs as it is often from their losses that bulls and bears reap their rewards (profits).

There are numerous styles of trading or personalities affording everyone opportunity to make money. Bulls and bears are in constant battle with pigs adding to volatility. The trick is NOT to invest in any instrument you do not fully understand.

If you don’t do your homework you will get hurt and lose money!!

Summary

- Having shares in a company give you claim on the assets and earnings as well as voting rights.

- Share are equity , bonds are debt. Bondholders are guarenteed a return whereas shareholders take on risk of the company not being succesful therefor requiring a higher return on their capital.

- You can lose all your money in shares. You can also make lots if you pick the right share.

- There are two types : common and preference shares and companies may create different share classes.

- stock markets are the places where buyers and sellers meet to exchange shares.

- The JSE is the major stock exchange in Africa

- Share price fluctuate due to the forces of supply and demand. Most important factor influencing price is earnings

- There is no hard and fast way to determine or explain price movement

- To buy shares use a broker or DRIPs

- Stock quotes and tables are easy to read - don’t be afraid of all the detail

- Bulls make money, bears make money but greedy pigs get slaughtered.