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Introduction This is a basic guide to investing on the JSE for those people that have never done this before. Because of this I make one simplifying assumption: you have already chosen to invest on the JSE or “in equity” as we call the shares that are traded on the JSE daily. In other words, this is not sales pitch about how you should invest, but just a source of basic education on how to open an account, decide which shares to buy, buy those shares, and eventually sell them. Secondly, I am not going into any detail about any particular shares or any aspect of finance or investment theory (you can find plenty of this in the rest of this website). This guide is meant to form a foundation from which you can go out and begin your own research in the directions that interest you. What are shares/equity/stocks? Shares (also called “stocks” in America and collectively called “equity”) are simply small slices in the ownership of a business. Holding one or more shares (this is called being a “shareholder”) in a company gives you the right to attend certain meetings (for example “Annual General Meetings” or “AGM’s”) and cast your vote in favor or against certain important decisions that the company has to make. Being a shareholder gives you a whole set of rights, but I will not go into this in any detail as the legalities are sometimes very complex. The most important (and truly only reason for) owning a share is that it gives you the right to the underlying assets that the company owns and the profits that the business makes. Unfortunately, it also exposes you to the risk that the business might make a loss and eventually go bankrupt. Due to the legal nature of companies, as a shareholder you can never be liable for the debts of the company, thus investing in shares limits your loss to the amount that you have invested. In other words, limited downside and infinite upside. (“Net” or “Final”) Profit is simply all sales of the company less all the expenses (including tax) for the period, which is often the prior 12 months called the “financial year”. You may have heard of a class of shares called “preference shares”. Most of the shares on the JSE are “ordinary shares” which exposes the shareholder to the greatest risk of all capital providers, but also allows him the greatest potential returns stemming from all residual profits that he has claim to. On the other hand, preference shares are often limited to a specific return determined at issue and they can take manyforms, but are often more like buying bonds (or fixed interest investments) than buying equity. In summary: buying shares in a listed company makes you a part owner of that business. How do shares make you money? Making money or creating wealth is the only reason anyone invests, thus all decisions in the market are motivated by this. As a private investor when you buy a share there are two ways that you can make money: the share price increases (we call this “capital growth”) and/or the company pays you some of its profits in cash (we call this “dividends”). Capital growth might increase your wealth, but you only see the money when you sell the share. Until you exit or realize the investment your money is tied into the company. Dividends, though, are paid by many (but not all) companies once or twice (or more times) a year as a fraction of the profits (companies tend to retain a lot of their profits to fund their future growth, which is often a good thing as this increases capital growth of the company latter on). Dividends are actually cash that goes straight into your bank account without you having to sell the shares to realize it. Dividends are presently tax free in South Africa, but this will be changing within two years into a system where they are taxed at 10%. Capital growth does not attract any tax until you sell the share. At this point you will probably have to pay Capital Gains Tax (CGT). In summary: in the stock market wealth creation comes from dividends, capital growth, and/or both. Initial Decisions How much should I start off with? I believe that there are two principles of safety that all investors should always try to maintain when it comes to deciding how much money they are going to invest in the stock market: - Only invest money you don’t immediately need and won’t need in the foreseeable future (the “Need Principle”). Investments work the best when they are held long-term and if you need to suddenly sell investments because you need the money then it is likely that you will loose money as well as incurring unneccesary transaction fees.
- Never invest borrowed money (the “Ownership Principle”). Besides the emotional stress this will cause you it also forces your investment decisions with the borrowed money to be short-term. Also, imagine the unfortunate scenario where you lose the money and are left without any money and a large debt…not a situation anyone should ever be in.
So long as you can fulfill both the Need and Ownership Principle you can start with any amount of money. Due to decreasing transaction fees of brokers, the more money you can start off with the better. Many brokers also won’t allow you to open an account with them unless you have a certain amount of starting money in the account. In my opinion, the absolute minimum amount you can start investing directly into shares on the JSE I would have to say it could started with as little as R10,000 or even R5,000. If you wish to start with less, then perhaps you should consider paying a monthly debit order into a market linked investment like Satrix... This amount of money, though, will obviously only be able to build a very small portfolio. But—especially with small caps—all you need is one of your shares to go to the moon to make lots of money. In summary, only invest your own money that you can afford to loose. Which Broker? I advise you to invest through an online broker, as the transaction fees are lower due to the automation of many of the processes that cause the broker’s costs. My recommended broker due to personal experience and their cost structure to information provided and services performed is Standard Bank’s online brokerage division, called Standard Bank Financial Markets. Still, depending on your starting investment size and your personal needs it might be worth looking at the other top online brokers: ABSA , Sharenet , and PSG . In summary, pick a reliable online broker that suits your needs. Technical Background on the JSE JSE Rules & Regulations The JSE's trading platforms can be traded through during the work week (Monday to Friday, excluding public holidays) from 8am to 5pm. All the companies listed on it are required to communicate certain major events with its shareholders and the public (for example financial results and the company’s own directors buying or selling its shares) through a media called “SENS” (“Stock Exchange News Service”). The SENS for each day can be found for free on Sharenet and ask your broker/search your broker’s website for historical SENS for companies. In summary, the JSE is open during the work week from 8am to 5pm and companies use SENS to communicate relevant news with shareholders. Buying and Selling Assuming you have decided to go with an online broker you will be entering your own trades onto the market, thus it is important to understand the mechanics of how buying and selling shares works. The JSE is a transaction driven market where a share can only be sold by a person if someone else is willing to buy it at that price. Likewise, a share can only be bought by a person if someone is willing to sell it at that price. If you want to buy 100 shares of VOX Telecoms (a listed company with the share code VOX) at 500c, but the only bids to sell it lies at 520c then you are faced with three (actually a lot more than three, but for simplicity we’ll say three) courses of action: do nothing and don’t buy it, buy it at 520c, or put a bid in to buy it at 500c. The outcome of the first option is obvious, but let me explain the other two options. With the second option you will buy (“get into” or “enter”) VOX at 520c (assuming that at least 100 shares were up for offer at 520c). In the third option you will place a bid to buy 100 shares at 500c. If no one decides to sell 100 shares at 500c then you will not get into VOX at all…but if someone does sell shares at 500c then you could well get into VOX 4% lower than if you just bought in at 520c. Bidding low is often a prudent strategy, but can sometimes leave you out of the race when you don’t get into a share because it’s growth leaves your bid behind. Another method of buying/selling a share is “at market”/”@market”, which almost always guarantees the completion of the transaction. For example buying 100 VOX @market is a directive to the broker to enter the market and begin buying VOX from all bids to sell it until he has accumulated 100 VOX for you. This often ensures that you get all the shares that you want, but sometimes means that you get them at prices that are not ideal. I do not recommend ever using @market orders; rather use targeted bidding above current levels, as this will ensure that there is a ceiling on the price you are willing to pay. The number of transactions that occur for a share in a day/week/month is referred to as “liquidity” with a share that is highly traded being referred to as being “very liquid”. Liquidity of a share is very important if you are planning to resell the share (in a hurry), but not that important if you are planning to get dividends from the share. You should always bearing liquidity in mind when entering a new share. This is because it might well become a factor if you are forced to liquidate for some or other reason and it can hurt your returns far more than transaction fees in this instance. In summary, the JSE is driven by matching willing buyers and willing sellers through the use of various types of orders placed through brokers on its trading platform. JSE Sectors, Indexes, & Diversification The JSE is broken down into a number of sectors, for example mining and financial services. These sectors can be broken down even further, for example gold mining, platinum mining, and mineral exploration. From these sub-sectors they can be broken down into even smaller segments: the companies. For example, Anglo, BHP, and
Simmers. The JSE’s total “value” can be tracked as the market capitalization of all its shares, called the “AllShare Index” or “ALSI”. This can be tracked to see how the overall market is doing. Likewise for each sector and sub-sector on the JSE. When people talk about “…the market is doing well…” they are often referring to the fact that the AllShare Index has risen a lot. Holding shares from different sectors on the JSE and in different companies is a method used to lower the risk that you will lose your money. This is called “diversification” and works on the basic premise that there is less chance that all the companies you hold will fail than if you hold shares in only one company. This follows the often used saying that one shouldn't put all your eggs in one basket. Bearing diversification in mind, don’t spread your portfolio too thin. Diversification has a hidden cost in how it waters down your portfolio’s potential returns through transaction fees and negatively correlated share price movements (ignore the last statement if you do not understand it). Basically, while diversification is useful for lowering risk, over diversification can hurt your investment returns almost as much as too little diversification. I believe in the following two diversification rules that I have developed and use myself to gain the advantages of diversification while minimizing the drawbacks: - Never invest more than 10% of your portfolio’s value into one company. More than 10% exposure to any single company leaves your portfolio open to significant risk of that company failing.
- Never invest less than 5% of your portfolio’s value into one company. Investing less than 5% in any single company is going to lead to a portfolio with significant brokerage fees, limited alpha return (returns in excess of the market) and sub-optimal decision making.
In summary, using the various sectors of the JSE you can (and should) build a sufficiently diversified portfolio. In Summary Owning shares or being a shareholder makes you a part owner in a company that gives you the chance to participate in and benefit from the profits of the company. The tangible increase in wealth comes in the form of dividends and/or capital growth. Buying and selling shares is done through live bids placed on the JSE between willing buyers and sellers and this can be done through brokers. Online brokers are recommended for this and tend to be the most cost effective option, as many of their processes are automated. You should never invest borrowed money or money you can afford to loose, as investing in shares should be a long-term decision. I recommend that you do not start unless you have at least R5, 000 (preferably at least R10, 000 or more) to invest and you practice diversification across the different sectors and companies on the JSE. Where to from now...?
And, finally, welcome to the exciting world of small cap investing on the JSE! I hope that you have found this introductory article useful and I would like to encourage you to delve further into both this websites resources and the entire stock market!
Kind regards, Keith McLachlan |
