PDSnet Online Investment Course

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In Module 2 we described how it was important as a private investor to establish whether you were in a bull or a bear market. If you are unclear on how to do this, you should go back and re-read Module 2 on the subject of “Managing Risk”. For the purposes of this module, we will assume that you have already determined that the share market is currently in a bull trend.
Your next problem, as a private investor, is to find the right share to buy. There are about 350 shares listed on the JSE – so you need to narrow this field down to a few potential opportunities that you can concentrate on. In this module, we will help you to do this by suggesting a number of “selection criteria”  that you can apply to eliminate unsuitable or uninteresting shares.
You are looking for a share which will perform well, but with minimal risk. We would like to begin by suggesting a few ideas that will prevent you from making the wrong choices right at the outset.
AVOID “THINLY TRADED” SHARES
Your first consideration when looking at a share should be, “Is there sufficient volume traded?” Some shares on the JSE are very “thinly traded” – which means that the volume of shares changing hands each day is very limited, and there are many days when no shares trade at all. You can recognise these thinly traded shares because they tend to have very “boxy” looking price graphs. This is because of long periods when there is no trade resulting in the chart having extended “flats” broken by the occasional deal which usually is accompanied by a sharp change in price. This tends to give the chart a “Lego block” look which is very different from that of heavily traded shares. Consider the example:
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Here you can see that this price chart has that “boxy” look caused by the long periods when it has not traded at all. For example, the “flat” from Early March 2020 to mid-June 2020. Compare this to the chart of a free-dealing share where millions of Rands worth of shares change hands each day:
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In general, you should ensure that the share you want to buy is “free-dealing” which means that it has sufficient trade to accommodate your purchase comfortably – and obviously your sale in due course.
The Three Times Volume Rule
A good rule of thumb is only to buy shares which trade at least three times what you want to buy on average each trading day. So, for example, if you want to buy 300 shares of a particular company, then you need to make sure that there are at least 900 shares changing hands on average each day. If you buy a thinly traded share (i.e. which trades less than that) you may not be able to sell it easily when you want to.
You can see the volume of shares changing hands in any JSE listed company in your software at the bottom of the chart, where there is a volume histogram (which can be turned “on” and “off” clicking the right-mouse button and then clicking on “volume”). In addition to this, in the second row of icons in your software at the top of the chart is the “data window” icon. If you click on this, the data window will open giving you all the daily data for the share. The data in this window changes as you move the mouse cursor left and right across the chart. If you have the volume turned on, then one of these items is the daily volume traded. From this you can get an idea of how many shares change hands on average every day. The data window can be added to any chart and it looks like this:
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Here you can see that this is the data window for Sasol on Monday 22nd June 2020. On that day Sasol opened at 11490c and closed at 14011c. The highest price it traded at was 14757c and the lowest was 13650c. It also shows you that on that day 3,252,859 shares changed hands worth about R455,7m.
You can immediately see that if you were wanting to buy or sell Sasol shares you would have had absolutely no problem because there were thousands of big buyers and sellers. 
Blue chip shares such as those in the JSE-FIN30 will generally have substantial daily volumes of trade, but when you begin to look at secondary shares which are more thinly traded, the “three times volume rule” may prove very useful.
Your software also shows whether the share’s liquidity from an institutional perspective. In the center above the chart for every share you will see the words “highly liquid”, “liquid”, “illiquid” or “highly illiquid”. This designation is primarily meant for institutional investors and so it is not really applicable to private investors who are looking to buy much smaller numbers of shares. You will find that even shares which are designated “illiquid” have plenty of volume traded for your purposes and to satisfy the “three times volume” rule.
AVOID COMMODITY SHARES
To begin with, we suggest that, until you are more familiar with the share market, you steer clear of commodity shares. These are shares whose focus is on the extraction, processing and marketing of a commodity – such as gold or platinum or oil. Our reason for warning you off them is that they tend to be considerably more volatile than industrial or financial shares. Consider, for example, the graph of Anglogold (ANG) over the thirty-five years between 1985 and 2020:
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<figcaption class="figure-caption">Anglogold (ANG): 1985-2020. Chart by ShareFriend Pro.</figcaption>
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You can see that this share has oscillated up and down as the rand price of gold changed and the local political situation impacted on gold mines. Anglogold finally ended up selling all its South African mines and concentrating on overseas mines because of the uncertainty which became part of gold mining with the mining charters introduced by the ANC since 1994.
By following this advice to stay away from commodity shares, you could immediately ignore about a quarter of the shares trading on the market and concentrate on the industrial and financial shares.
STICK TO “BLUE CHIP” OR HIGH-QUALITY “SECONDARY” SHARES
Some of the shares which trade on the JSE have a very long history of generating good profits and paying good dividends, year after year. These companies are known as “blue chips” and are very much sought after (i.e. they are “highly rated”). But which are the blue-chip shares? Usually they are companies whose names you already know – like Pick 'n Pay, Standard Bank or Imperial. A good place to look for the best and biggest blue-chip shares is in the JSE Industrial and Financial 30 index (J213) which includes the 30 largest industrial and financial shares on the JSE. You will find this in your software database under the name “JSE-Fin30”.
These companies have a history of making excellent profits and paying solid dividends every year. You can expect most of them to pay out a dividend which is roughly 2,5% of their share price, on average, every year – and you can expect their share prices to double approximately every 5 years. They also have the important advantage that they are very “free dealing” – which means that millions or even billions of Rands worth of their shares trade every day, making them easy to buy and sell in a matter of minutes.
Using the Dividend Yield on Blue Chips 
If you see a high-quality blue-chip share trading with a “dividend yield” of around 5% or more – then it may very well be an excellent buy. The dividend yield will be explained in more detail in module 8. Each company’s dividend yield is given for any date on company’s chart in your software. Look at the information bar, just below the tool bar at the top of the chart. You will notice that the information in the information bar changes every time you move the mouse cursor left or right – this is because it shows the value of certain ratios (like the dividend yield) on the day where you have the cursor. The next day all this information, such as the share price (the “close”), dividend yield (DY) and the earnings yield (EY), will have changed.
 NUMBER OF DEALS
Another very good way to establish whether a share is well traded or not is to look at the number of deals traded per day. This is also shown in your software directly below the liquidity indicator in a chart. Generally speaking, if the daily deals of a share are below 100 you should be a little cautious and check the liquidity indicator as well as the history of the share. There is, for example, a huge and important difference between a million shares traded in a single deal on a certain day and a million shares traded in 500 deals on that same day.
 THE THREE QUESTIONS
 Before buying a share, you should ask yourself three important questions:
“Is the share itself in an upward trend?”
“What is the current trend of the sector in which your share is located?”
And 
“What is the current trend of the whole market?”
To a certain extent, we could answer these questions in a fundamental way. For example, headlines like “Financial Institutions will benefit from the forthcoming upturn in the economy”, or “Industrial demand for platinum is likely to increase”.
The importance of tracking the market as a whole and the major sectors cannot be over-emphasised. It is well-known that the shares within a particular sector tend to move up or down together and the market as a whole is usually either in a bull or a bear phase. With a few exceptions, it is much harder to pick shares that are going against the trend, and it is harder to make money by going against the market. Your chances of success are greatest, therefore, if you buy:
Shares that are rising in sectors that are rising in a market that is rising.
In addition to this, tracking the market as  whole is important so that you can assess when it might be nearing its peak, and consequently when to sell your shares.
MARKET CARPETS
One of the great unique features of your software is its ability to produce “market carpets". This feature can be found in the menu at the top of your screen under “Scans”. What it does is to rank the various market sectors based on how much they moved up over a period that you choose. So, it shows each sector as a square which is coloured from green to red. Green shows the sectors that moved up and red the sectors that moved down over the period which you have selected. Then, within each sector square, the smaller coloured squares represent the individual shares and their colour shows whether they went up (green), went up slightly (light green), stayed the same (white), were down slightly (pink), or went down strongly (red). If you hold your mouse over these smaller squares, the software will display the share’s name, gain or loss and its starting and ending prices. You will also see on the right-hand side a small chart of the sector over which you have your mouse and if you click on the sector squares it will display the individual shares in that sector with their charts in the small graph on the right.
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<figcaption class="figure-caption">ShareFriend Pro Market Carpets Feature</figcaption>
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In this example of the Market Carpets features, you can see a market carpet diagram over two years, but you can choose any period from 1 day to 5 years.
The market carpets feature enables you to view the entire JSE over whatever period you like quickly and effectively. You can easily use it to pick out the winning sectors and the shares in a particular sector. 
WATCHLISTS
The JSE has approximately 350 listed companies which we call the “Universe of Shares”. As a private investor you will be trying to pick the best of these shares to have in your portfolio. Obviously, there are far too many shares for you to keep your eye on all of them, especially if investment is a part-time activity or hobby for you. It is therefore advisable to narrow down the field and create a “watchlist” of interesting looking shares – shares which might offer the possibility of a significant capital gain. We recommend that you should aim to have about 30 shares in your watchlist. You will find that your charting software allows you to compile and maintain as many watchlists as you like.
To add a share to your watchlist simply use the right mouse click to bring up the menu and then click on “Add to Favourites” or “Add to Watchlist”.
So, as you are reading your business newspaper or watching a business program, you may come across a company that interests you. Add it to your watchlist.
Having a share in your watch list means opening a file for that share and accumulating as much information about it as you can. Get hold of the most recent financial statements (usually available from the company itself on its website in the form of a downloadable PDF file), cut out articles from the newspaper and visit the company’s website. Make notes of your thoughts on it.
Your software allows you to add your own typed notes to the shares in your watchlist or you can keep hand-written notes in the share’s file.
From your watchlist, your objective is to choose between 5 and 8 shares to buy and hold in your portfolio. Less than 5 shares expose you too much to the risk that one of the shares gets into difficulties, while more than 8 shares involve too much work and does not significantly reduce your risk.
Obviously, if you are just starting out, you will save your money in your stockbroking account until you have sufficient (at least R10 000 – otherwise your dealing costs will be too high) to buy your first share. Once this is done, you will begin saving again until you have enough to buy another share, and so on until you have at least 5 shares.
So, to summarise, from the 350 shares listed on the JSE, you will choose, say, 30 to put into your watchlist and then from those you will chose between 5 and 8 to own in a portfolio. Of course, the JSE is changing all the time with new shares being listed and other shares delisted.
At the same time the list of shares which you are watching will change because you will always be looking for new shares to watch and, on investigation, you will realise that some of the shares in your watchlist are not as interesting as you thought they might be. When adding a share to your watchlist, you need to ask yourself whether in your opinion it has the potential to be one of the top 2% of opportunities on the JSE. If not, then don’t waste your time with it.
Remember, in the share market, time is your most important resource, not money – because how you spend your time will determine how you spend your money. Every share that you add to your watchlist and your portfolio will spread your available time more thinly.
Obviously, you want your portfolio to be diversified – so that you don’t have “too many eggs in one basket”. Each additional share that you add to your portfolio reduces your risk. So, if you have only one share you are totally exposed to the fortunes of that share. If you have two, your risk declines substantially. When you add a third share your risk declines further – but not by as much as it did when you added the second share. A 4th share will again reduce risk but not by as much as the 3rd share – and so on. Studies in the United States have shown that the marginal reduction of risk by adding an additional share is insignificant beyond the 8th share. So, it is a trade-off between reducing your risk and spreading your time too thinly. That is why we advocate owning between 5 and 8 shares. 
WATCHLIST CRITERIA
When considering which shares you should add to your watchlist, you need to establish and apply some carefully considered criteria. These criteria are the factors which you will use to narrow down the field of shares that you watch. Obviously, everyone has a different risk profile and objectives for their investments, but here are some examples of criteria which you may wish to apply to a share before you begin watching it:
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<li>Volume - A good place to start is with the share’s volume traded. This should be your first criteria because very thinly traded shares cannot easily be sold on stop-loss (we explain the basic stop-loss strategy in module 12). You may be able to buy them, but you will find it difficult to sell them when you want to. We suggest you adopt the “three times volume rule” - which we discussed earlier in this module. In terms of this rule, you will not buy a share unless it has at least 3 times what you want to buy trading on average every day. So, for example, if you want to buy R10 000 worth of a certain share then you need to see at least R30 000 trading in that share every day over the past 30 days. To establish what has been trading in a share over a specified period first make sure that the share’s volume histogram is showing at the bottom of your screen by using the right mouse menu and clicking on “volume”. Then look for the “Volume MA” feature in the bottom left-hand corner of your screen. This feature enables you to apply a moving average to the daily volumes traded on the share. If you choose the default, the computer will add a 30-day moving average to the volume histogram. Next then click on the “data window” icon 
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at the top of your screen. Using the window which opens you will be able to see what the average volume was over the 30 days immediately before the date where you position your mouse. This can then be multiplied by the current price (the close) to get the average value of shares traded over that period. You could, of course, decide that you want to be conservative and use a longer moving average of the volumes – or you could decide to only look at shares with four times the value you want to buy traded every day on average. These adjustments will depend on your risk profile.  </li>
<li>Industry - So then let’s assume that the share passes your volume test, then you probably want to consider which industry it is in. As mentioned earlier, some industries are very volatile and so you may want to avoid them. The typical example is the mining industry. Mining companies are totally dependent on the price of the commodity which they produce – and usually the price of that commodity is set on an international market in US dollars. This means that a major factor impacting that price will be the rand/dollar exchange rate. The combination of a volatile currency and a volatile commodity price can make mining shares extremely volatile – especially if they are “marginal” producers – meaning that they are operating at break-even or very close to it. The prices of such shares move around like the proverbial “cat on hot bricks” as the rand price of their commodity alternately makes them profitable and unprofitable. So, you may decide, “No commodity shares”, which will eliminate about a quarter of the shares listed on the JSE. </li>
<li>Profitability – So if the share has sufficient volume traded on average every day and it is in an industry which you like, the next consideration will probably be its profitability. There are many ways to measure profits and set criteria, but a simple starting point might be to just look at the history of the company’s headline earnings per share (HEPS) over the past ten years. This is given to you in your software in the “Current Company Comments” icon 
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at the top of your screen. If you click on that when you are looking at the chart of any share which interests you, you will see a page of information at the bottom of which is a table of financial data going back usually 10 years. It shows EPS (earnings per share), HEPS, DPS (dividends per share) and NAV (net asset value). These concepts are fully explained in module 8. Look at the HEPS – by just scanning this record you will be able to establish what has been happening to the company’s profitability over the last ten years – and then determine the criteria you want to set. For example, you may say that you are not going to look at companies which grow their earnings by less than 10% per annum on average over the past ten years. Or you may want to combine the earnings track record with the company’s Price:Earnings ratio (P:E) and use a price:earnings growth ratio (PEG). If you are not familiar with the PEG ratio and its use, do not worry because this is fully explained in module 10. </li>
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<li>Union exposure – Union action is a constant feature of the South African economy because the labour legislation is skewed heavily in favour of the employee and against the employer. So, any company which has a significant semi-skilled or unskilled workforce can be the subject of disruptive strikes. This has had a particular impact on the mining industry, adding to its woes – but there are sometimes strikes in the manufacturing sector and retail sector and any other sector where the unions have significant membership. You may choose to avoid these industries altogether or to at least include this as a factor in your share assessments.  </li>
<li>Rand Exposure – Many companies listed on the JSE get some or all of their revenue in a hard currency such as US dollars, euros, yen or British pounds. These companies benefit when the rand weakens because they get more Rands for the hard currency. Some companies are completely located overseas but listed on the JSE. Others simply have a percentage of their operation in a foreign country. For example, Prosus’ major asset is its 31% stake in Tencent which is listed in Hong Kong and runs a massive social media and gaming business in China. Every time the rand falls against the dollar Prosus benefits – and vice versa. It is almost impossible to avoid rand exposure on the JSE, but you can at least quantify it to some extent and make decisions about the degree of rand exposure you would ideally like. Companies which import from overseas struggle when the rand weakens because they have to keep putting their prices up – but they benefit when the rand strengthens. </li>
<li>Working Capital – A company’s working capital can be calculated by adding its stock and debtors and then subtracting its creditors. This gives the value of capital which is tied up in the on-going working of the business. Companies which have a large amount of working capital are generally much more difficult to manage than companies with little or no working capital. Service companies usually have very little or even no working capital and some even have negative working capital because what they owe their creditors is more than the value of their stock plus their debtors. These are generally the best investments on the JSE – but because of that they usually trade on a very high multiple (price: earnings ratio). In other words, they are expensive. The very best type of company from an investors point of view is a service company which has little or no working capital and receives most of its income in the form of regular debit orders from existing clients – which is known as its “annuity income”.  The worst type of company is one in a very competitive industry which has enormous working capital requirements – such as the chicken business. </li>
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<li>Competition – A company in an industry which has intense competition will always find it difficult to increase its prices and generate good profits because there will be many substitutes. A very good example of this is the clothing or retail industries. In these businesses, there are many of strong players all competing for the consumers’ surplus cash. The clothing industry is particularly cut-throat with several overseas brands like Cotton On competing with more established players like Woolies, Mr Price, Foschini and Edgars. Companies which have a relative monopoly have an advantage in pricing. A good example of this is SA Breweries which is now part of Anheuser Busch. They control as much as 90% of the South African beer industry. Their only real competition aside from a small number of craft beer producers comes from substitute beverages like ciders, wines, spirits and carbonated soft drinks. The degree of competition in the industry which a company occupies is important because it determines their pricing power. Service companies which are exploiting a new technology can sometimes create a degree of pricing power until competitors come in and force them to reduce prices.</li>
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You will probably come up with many other criteria which would make a share more or less attractive to you. In fact, this training program is really about enabling you to make intelligent decisions on your specific criteria and exactly what you want from your investments.
 
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