Page 4 - SHB 2020 Issue 1

How To Identify Shares Worth Buying

A Quick Intro: The Art of Share Investment
Over the long term, the stock market has proven itself over and over again to be the best performing
asset class. A diversified share portfolio, on average, will beat cash, property and bonds over 10 years
or more.
This is not surprising when you consider that successful businesses are the driving forces in most
economies – and shares represent part-ownership of those businesses.
When you buy shares in a listed company you become one of the shareholders and share in the compa-
ny’s profits. You will also get dividends – cash payments – if and when the company declares dividends.

Investing vs Speculation (Trading)
This article is about shares worth buying as investments – in other words, shares you can and
should hold for five years or more.
The focus here is not on buying shares for quick profits. Trading, or speculation – which means
holding shares for very short periods, like days or weeks – requires a different approach.
Trading is difficult. It might look easy in hindsight, but the market is unpredictable – and more so in
the short term.
Although the long-term trend of the stock market – looked at over decades – is upward, shares go up
and down a lot in the short term. Short-term movements in share prices are impacted by all sorts of
events, many of which are impossible to predict.
Long-term trends, on the other hand, are determined mainly by business growth and profitability. By
buying and holding shares in companies that are steadily increasing turnover and either increasing or
maintaining profits, you can create a share portfolio that delivers great investment returns.
Building an Investment Portfolio
Diversification is a key consideration in building a solid investment portfolio.
It’s generally a bad idea, as the saying goes, to have all your eggs in one basket. In the same way, you
don’t want all the shares in your portfolio to be the same types of businesses.
This is because the companies in JSE sectors often rise and fall together. If commodity prices are
strong, for example, the share prices of most mining companies will rise. If consumer demand is
weak, the share prices of most retail outlets are likely to fall.
A diversified portfolio is one that covers all the main sectors of the stock exchange (and, therefore,
of the economy). A diversified portfolio will probably also contain both value and momentum stocks.
What is Value Investing?
As the phrase suggests, value investing is the stock market equivalent of “bargain hunting.” A value
investor is looking for companies that are cheap in relation to their profit potential.
Bear in mind that “cheap” in the stock market has nothing to do with whether the price of a share is
R10 or R1 000, but rather how the share price relates to the company’s profits. If a company’s shares
cost R10 and the company makes R2 profit per share every year (a price/earnings ratio of 5), the
shares are cheap. If shares cost R10 and the company only makes 20c a year in profits (a price/earn-
ings ratio of 50), the share is expensive.

What is Momentum Investing?
Buying shares that have been rising steadily in price on the belief that the trend will continue is
called momentum investing.
The phrase derives from the idea that once a share has a strong upward trajectory the “momentum”
is likely to continue.
Momentum shares are often relatively expensive (ie, in relation to their profits) because investors
are expecting strong future growth. If a company is growing profits by 50% a year investors are happy
to buy the company’s shares at a P/E of 30 because the “forward P/E” (the ratio based on future
profits rather than past profits) is actually 20 rather than 30.

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