By James Lennon
Senior Analyst at Fat Prophets
For those individuals not familiar with investing in public companies, taking on a more active role in managing their share-based investments can require a steep and often costly learning curve. While the medium-term benefits usually outweigh the near-term costs, there are a number of tips and tricks that can help the uninitiated hit the ground running.
Here are some of our best pointers for navigating the investment minefield.
Investment jargon and concepts
The first port of call for any budding share investor should be a website (i.e. www.investopedia.com) or a book (i.e. Wall Street Lingo and/or McGraw-Hill Dictionary of Wall Street Acronyms, Initials, and Abbreviations) that provides the reader with the necessary information to formulate their own stock ideas. By becoming familiar with all of the investment concepts and associated jargon, the individual investor will be able to develop the investment style and methodology that is best suited to them.
While there are too many investment concepts to detail in this article, the two key principles in our view are the relationship between risk and reward (i.e. based on the assumption that the share market is efficient at pricing risk, lower risk investments will offer lower returns, and vice versa) and the time value of money (i.e. based on the risk-free rate, the idea that money available today is worth more than the same amount in the future).
To make life more difficult for the uninitiated, a lot of these investment concepts are often explained using acronyms. Perhaps not surprisingly, these acronyms are as diverse as the investment concepts that they relate to. Common acronyms include FY for financial year, ROE for return on equity, EPS for earnings per share, CAGR for compound average growth rate, EBITDA for earnings before interest, tax, depreciation and amortisation, NPV for net present value, and LFL for like-for-like.
Company research
Once the individual has a basic understanding of the various investment concepts and the associated jargon, it is time to start looking at potential investments. The best way to fast track this process is to (i) let curiosity get the better of the individual and look at companies and brands that they relate to on a daily basis, either directly through the corporate’s website or the Australian Stock Exchange’s website (www.asx.com.au), and (ii) digest financial media (i.e. https://www.afr.com/share_tables/).
When screening the broader share market for potential investments, there are a number of guiding principles that can help narrow down the search. The first approach is to look at the market from a top-down perspective by focussing on broad economic themes that help identify which market sectors are most attractive. The second approach is to look at the market from a bottom-up perspective by focussing on company specifics such as share price performance and valuation.
Either way, the ultimate goal is to establish a short-list or watch list of companies that can be researched in more detail at a later date. While a company’s annual reports and prospectus are the key resources from which to make an informed investment decision, this should be supplemented where possible by reading all of the company’s and its peer group’s market releases and press coverage. Test-driving products/services (if possible) and technical analysis can also be beneficial.
Broker research
While it is important for each individual to form their own view regarding a stock’s investment potential, cross-checking this with broker research can be worthwhile. However, before venturing down this path, there are two important points to note. The first is that broker research can be expensive to access. The second is that broker research is often not independent and as such can often have a hidden agenda. These points considered, broker research can nonetheless be useful.
Portfolio construction
Once an individual has refined the shortlist of potential investments through research, it is then time to make the investment(s). Having taken the time to research the business model of each potential investment, the individual will now be able to determine a price range at which the stock’s potential rewards outweigh its potential risks – this can be done by qualifying the company’s strengths, weaknesses, opportunities, and threats and factoring in a risk buffer (i.e. a margin of error).
In our view, the price at which an investment is transacted represents the single most important point in the investment cycle. For this reason, it is important to remain patient and only buy the company’s shares within the predetermined price range. Of course, due to the dynamic nature of the share market, individuals need to recalibrate their price expectations on a regular basis. As is the case with buying shares, selling shares should also be guided by the predetermined price range.
Aside from top-down and bottom-up considerations, there are a number of other factors that individuals should be aware of when setting up their share portfolio. These include (i) share liquidity, which is particularly relevant for individuals that have used debt (i.e. margin loans) to fund part of their share portfolio, (ii) diversification by market sector, market capitalisation, and region, and (iii) the number of stocks that are included in the portfolio.
Summing up
While the share market can often seem like a step too far for the uninitiated, there are a number of things that a budding investor can do to ensure they hit the ground running. These include (i) developing a basic understanding of the investment concepts and associated jargon that are used by public companies, media, and brokers, and (ii) realising that there is no substitute for hard work (i.e. research) and that the companies, the media and brokers often airbrush the facts to suit themselves.