Advanced Equity Trading

1. Advanced Equity Trading Gavin Bramley Share Direct

2. Know this about every share in your portfolio • Financial year end – interims • LDR – last day to register • Earnings Yield • Low : Highly rated • High – poorly rated • Level of borrowings • Profit trend (EPS)

3. Finding winning shares • Structured / organized search - wide • Consider best sectors – potential • Narrow list with criteria • Volume test (liquidity test)– min R500.000 / day recommended • Earnings Yield (Not too high or too low) • Is share in Upward or downward trend • Avoid Extremes – share doubled..in future • Trend (5-10 years)

4. Fundamentals • Gearing exposure • Asset intensive – depreciation • Consumer monopoly vs commodity type • Be interested in what they do

5. Analyse : Gold Mine • Mature • Established • Developing • Short life

6. Principles of Fundamental Analysis • We are principally looking at which shareswe would want to buy, but remembering that we would only do so if the price is right from a business perspective. • In fundamental analysis we would typically adopt a long-term buy and hold strategy • Consumer monopoly vs Commodity

7. Intrinsic Value • Warren Buffett • “..the intrinsic value of a business is the projected annual compounding rate of return that the investment will produce”. • This annual compounding rate of return is then compared to other investments. If the money to be invested can generate a higher return elsewhere for the same or lesser risk, then the proposed investment should go to that investment. • Determine business value in 10 years • We want to invest in company’s whose earnings we can predict.

8. Two types of business • a commodity-type business whose earnings fluctuate making the task of forecasting earnings difficult if not impossible; and • a consumer monopoly whose earnings (EPS) can be forecast as they have little or no competition and so profitability is assured. Consumer monopolies are more profitable than commodity type businesses and hence our focus is on these types of businesses.

9. Consumer Monopoly • Price does not affect the quantity sold because it is the only firm in the market or because its products not substitutes for another product. • Barriers to entry. Investment in infrastructure. • Protected environment - Telkom • Consumer monopolies generate large sales revenues • Unlikely to experience a cash flow problem or to be in debt. • Household names such that it would be unhealthy for other businesses NOT to stock products – coke / Castle

10. Commodity-type • Competes on price • Products are substitutes • Needs to retain earnings to replace capital items. Depreciation • May be highly geared – borrows to supplement cash flow

11. Selecting the profitable equities?Look for consistent returns (EPS)

12. Calculate the Per Share Growth Rate HP 10 B Calculator….

13. Next:Calculate the Initial Rate of Return • The earnings per share are determined by the performance of the company, but you must decide on the price that you will pay for that share • the higher the price you pay for the share, the lower your internal rate of return will be • you may have to be patient and wait for the price to fall before you buy if IRR is too low.

14. Calculate IRR - example The less you pay the higher IRR and visa-versa.

15. Put them together CRM as a bond would give us an initial return on investment of 11.56% per annum but would increase this return by 36.34% p.a.

16. Predicted EPS and Share Price at ROI on 16.09.2003 of CRM

17. Ensure that return on shareholder’s equity is high (ROSE).

18. Projected Values 10 years hence

19. Be warned, though, if company profits remain the same and you decrease the number of shares in circulation, the earnings per share and share price will go up. If you increase the number of shares in circulation, the earnings per share and the share price will go down. Management of companies know this and can abuse this principle to make very ordinary results look a lot better. A simple check is to compare the companies’ actual net earnings annual compound growth rate with the annual compounding growth rate for per share earnings. Buys back its own shares?

20. Are retained earnings being used to increase shareholder value? • Companies do not usually pay the full earnings per share as a dividend preferring to retain a portion for further expansion, replacing assets or to bolster their performance when times are tough. • As investors we would want to know what management are doing with our profits. Are they using them effectively? • My rule is, “If management can use the retained earnings of the company effectively to generate further increases in the share price, then I am happy to let them keep those retained earnings. If not, then I would rather have the retained earnings paid to me as a dividend”.

21. How do I get the information? • Identify the companies that you wish to evaluate. • Phone them. Tell them you are managing a small portfolio, and that you would like to consider an investment in their company, but that you require ten years’ worth of financials to make that decision. • Ask them to send you the information in whatever format is easiest for them. You may end up with some photocopies, but the bulk will have their annual reports, dating back ten years, in all its glossy glory. • You might also find that this information is sold in the format of computer programs offering regular updates of all fundamental information by the various companies who sell stock market charting software.

22. Rights Issues • Raises money from existing shareholders • Growth, premises, R & D • Cheaper than overdraft • Interest vs. dividends from surplus cash • Starts with S/holders meeting – motion to issue shares – decision 1 share for ‘x’ held • S/holders must note important dates.

23. Rights Issues – NB dates • Last Day to Register • Day on which eligiblity is determined for offer • Ex-Rights date – date after LDR • Opening date of offer • Date from which company accepts letters of allocation • Closing date of offer • Date by which letters of allocation must be returned

24. Rights Issues – Nil Paid Letter (NPL) • Are transferable to ensure take-up • Also offered at below market price • NPL’s have a tradable value on the stock market (separate listing) • Owners of NPL’s must still pay the take-up price.

25. Example: ( 6 for 10)

26. Impact on shareholder • Each share now worth 262.5 • Rights offer at only 200, profit 62.5 • Value of NPL is thus 62.5 being the difference • NPL’s can be geared • After closing date NPL’s are worthless

27. Share price raises 20% NPL: (300 – 200 = 100) Increase of 60%

28. Underwriting & Sponsoring Rights issues require: • Underwriters guarantee to take up unwanted shares to ensure finance is raised. • Paid a fee for doing so • Sponsoring Broker • Advises on structure of the issue • Assists with getting issue accepted by JSE committee

29. New Listings • Requirements to list • Certain size • Minimum pre-tax profits • Reasonable trading history • Minimum number of shareholders • Spread of shares amongst the public

30. New Listings : Prospectus • To make public aware of financial position of the company and why it needs additional capital • Promotes ability to make an investment decision • Prospectus includes: • Articles of association, directors remuneration, borrowing powers of directors, shares application form, assets of the company, auditors report, loan capital and borrowings, statement of assets & liabilities, profit history, subsidiaries, material contracts, expenses of the issue, brokerage fees, underwriting & minimum subscription, dates and times of the offer

31. Private Placement • a new listing not accompanied by an offer of shares to the general public • usually means the publics portion of the shares has been allocated by way of a private placing • A private placing is a preferential offer to institutions and companies associated with the company seeking a listing. • offered via a sponsoring broker • offers enormous profit potential because companies that are able to arrange a private placing are normally high-profile

32. Public Offer • Public may subscribe • “Stag” ~ apply and sell on listing to make quick profit • Oversubscribed – only get a % - pay 100% • Many small applications vs One large app.

33. Company’s reasons to list • Cash flow • Reduce gearing (investment vs borrowings) • Expansion programs • Disinvestment from a country • May allow existing owners to realise (re-invested) profits. (Bull market make it attractive) • Family owned Vs professionally managed

34. Cycles • Technical analysis is based on the assumption that share prices move in repetitive patterns • : trends, formations and cycles • Past modules dealt with trends and formations • We shall deal with cycles and waves • Recall psychology

35. Cycle theory • … and group investor behaviour suggests that natural cycles such as the seasons, the phases of the moon and perhaps some mystical “biorhythm” of mankind, influence investors to trade at predetermined intervals. • Some cycles are obvious – coal / orange juice • Dow Theory, Elliott Wave, Kondratieff

36. Difference between cycles and waves • “wave” theories postulate a regular pattern • Elliott is a wave theory • “cycle” theories postulate a regular time frame. • Kondratieff is a cycle theory

37. Cycle theorists • maintain that shares, share markets, sectors, commodities, exchange rates and almost every commercial data stream move in regular cycles. • They suggest that cycles are repetitive and of relatively fixed duration making them predictable

38. Three cycles moving together

39. Cycles • help to identify the lows and highs and to time your transactions • use momentum indicators of different lengths • a 5-day momentum simply takes each day’s price and subtracts from it the price of 5 days ago • difference oscillates around zero - the more pronounced peaks and troughs should highlight the underlying cycles • NB – other cycles at work may obscure

40. Cycles - warning • Need Volume to test for cycles • Thinly traded – not enough investors at play • One investors actions can nullify calcs.

41. How do I reduce risk? • Diversification • Warren Buffett, one of the world’s richest men, cautions that diversification is something people do to protect themselves against their own stupidity

42. How is this possible? • The answer lies in the fact that these four asset classes do not move in perfect synchronisation. Their movement creates a wave-like effect, in that as some assets struggle, others help to push the portfolio along. To take advantage of this effect you have to periodically rebalance the portfolio by selling some or a portion of the winners of each year and investing the proceeds into the losers. • The market works in cycles

43. 4 Assets and a Portfolio

44. KONDRATIEFF

47. Kondratieff • is a wave of commodity prices rather than business activity levels or stock market prices. • It is a cycle of inflation and deflation, not of boom and bust.

48. Kondratieff – Phase 1- spring & summer • 20 years of strong growth and rising commodity prices, which end with a major war. • Associated with major technological advances and rising confidence. • Businesses reach production capacity and begin to expand capacity. • Over investment finally causes distortions which are reflected in political tensions, economic instability and eventually war. • The wars referred to are the war of 1812, the American Civil war, World War 1 and Vietnam. • Opponents point out that there was no World War 2.

49. Kondratieff – Phase 2 - Autumn • The war is followed by a sharp primary recession lasting three or four years and then by a decisive recovery. • This is followed by a declining plateau of commodity prices where normal business conditions reach periods of intense prosperity.

50. Kondratieff – Phase 3 - Winter • A deflationary collapse in which the money supply shrinks dramatically as a result of bank collapses. • This draws the stock market down and general business activity levels decline sharply with spending power.