Module 3 ► Investments in the Securities Exchange
To make it easier for our busy readers to scroll directly to the items they are interested in
without having to read through all the material, we list the issues covered in this module:
The stock market (basic concept)
Understanding odds and probabilities
What cause share prices to move
Successful trading on the stock market
Tips for starting a share portfolio
If you are interested in accumulating useful information about stock market investments you
may want to copy this module and add it to the others published in order to build your own
manual of useful tips to assist you with successful investments in the equity markets.
The stock market (Securities Exchange)
The stock markets are long established sound operations which operate under very strict rules
and regulations where integrity and transparency are extremely highly rated and maintained.
No insider trading or any other frowned upon practices are allowed and even the listing of a
company may be suspended for not submitting their financial statements in time as prescribed.
The stock market is the ideal platform for gaining or disposing of some ownership or interest in
any listed company of your choice.
These transactions can be done within seconds at a very reasonable cost and does not require
any burdensome procedure, legal expenses, transfer fees or other obscure charges to be paid.
The stock markets have little tolerance for lies, fancy theories, investment philosophies and
other non-verified historical wisdoms. Let us face it, there are not many investment platforms
where you have such reliable history and receive such clear feedback so soon from several
daily media sources on your actions as you will on the stock markets.
It is estimated that as much as 80% of all investments in the world are directly or indirectly
linked or related to the stock markets in one way or another.
Apart from the institutional investors, it is also estimated that around 250,000 private individuals
directly participate in stock trading in the RSA (retail investors).
Whilst the FTSE/JSE is one of the bigger emerging market exchanges it is interesting to note
that almost 100 million private citizens in China alone directly trade on the securities markets.
֠ There are only two reasons for not having a share portfolio:
You don’t have the money to participate in this exciting and rewarding instrument.
You are ignorant of the excellent opportunities and returns offered by this facility.
Understanding odds and probabilities
You probably heard or read about many of the little "secrets" of how to select the best
shares on the stock markets ... some say it is all in the charts and technical indicators,
others say nonsense, it is all about earnings ... how much money will the company make
next year, some say it is all about business fundamentals or enterprise models and cash
flow, others again are convinced it is all about market cycles, shift catalysts, environment
impact factors, industry developments, etc.
There must be many different things that investors all over the world will swear by as being
the most effective selection criteria to be used if you want to select the best stocks.
During the past eight years of research done by Valana we could not even get a reasonable
level of agreement amongst the 26 top stock market wizards we studied as to the best
criteria to be used for effective stock selection.
We, however, established that as with most things it is really all about odds and probabilities
and that one, with the right skills and knowledge, can actually fairly accurately determine the
odds and assess the probabilities for the stock of a company to perform well or not in the
coming performance period of that company.
To understand this concept better one should look at odds as being the internal factors or
driver (bottom up business fundamentals) of the company and the probabilities as the
external elements (top down environment issues) surrounding the company.
What cause share prices to rise and fall?
The fallacy of logic
The biggest mistake many investors make is to think that it all comes down to simple
reasoning, common sense, logic and rationale.
They simply forget that it is people who trade on the Securities Exchange and people are
seldom guided only by logic and rationale ... they are mostly driven by greed, fear, emotion,
hope, perceptions and many other unreliable or even unpredictable sentiments and
A good example to demonstrate the lack of logic and rationale amongst investors is the
situation with Didata during the Information Technology bubble in 2002 when even
seasoned investors still joined the buying frenzy when the PE ratio (price multiple) of that
stock was already above 80 and this while most of them would admit that caution is called
for when the PE ratio of a stock moves above 20.
In other words, if one interpreted the above behaviour one would have to accept that they
were prepared to wait more than 80 years just to get their investment back.
As we may recall, that particular stock dropped more than 90% soon after this crazy
investment behaviour at the time.
Another good example is where Old Mutual dropped to below R5 per share in 2009, but
many “expert” commentators and brokers alike still advised against buying those shares
and that at a time when Old Mutual's interest in Nedbank alone was worth more than R5
In other words, they actually said that investors should avoid Old Mutual shares even if they
could get it free of charge.
Fortunately, the smart money investors who mastered the art of ignoring market noise
made a handy 170% on these shares in only a few months early during 2009.
A product of supply and demand
The price of a stock is nothing more than the product of supply and demand.
The more bids there are (buy actions) for a particular stock, the more the price will go up
and the more offers there are (sell actions) the more the price will drop.
Therefore, there can never only be sellers or only buyers on the market, for every seller
there must be a buyer. If everyone wants to sell who will be left to buy?
During market crashes or very volatile scenarios one often hear analysts and media
commentators say that investors are taking their money out of the stock markets.
This, of course, is a load of nonsense as no one can sell their stake if there is no one to buy
it. Therefore for every Rand taken out of the market by an investor another Rand enters the
market in its place.
Successful trading on the stock markets
The key to successful trading is twofold
First of all one has to determine who makes the market move, in other words, who has
the most influence on the price movements of listed shares.
This part is easy as the "big players" have by far the most impact on share movements as
they, on average, daily trade around R5bn on the JSE alone.
These big players are mostly institutional investors such as insurance companies,
collective funds, hedge funds, pension funds and also offshore fund managers, large
portfolio managers, etc.
The second part is trickier and the Valana team soon discovered that there are no
formulae, magic models or mystic processes that one could devise to select only good
stocks to invest in.
The most appropriate method seem to be the ability to identify certain bottom up and top
down matrix patterns and to recognise the probable weighting placed on such patterns by
the “big players” in the market when they consider companies to invest their funds in.
In other words, if one knows what they will consider to be important and one can also
anticipate how they will be looking at it, you will often be able to determine the odds for
them investing in those companies.
Nothing can be seen in isolation
We also discovered that no single element or characteristic could be used in isolation to
fairly assess future share price trends.
Therefore, price/earnings ratios, return on equity, profit margins, return on assets
managed, net asset value, price to book ratios, dividend yields, earnings growth,
discounting future growth in earnings, acid tests and all the other many popular data seen
in isolation, tells you less than what you would like to believe.
Getting it right ... most of the time
For almost eight years the Valana team focused all its attention on the matrix patterns,
interrelationships and weightings of different enterprise elements and components in
order to identify some common denominators favoured by the "big players" in the
During our research, we identified several interrelated factor groups and also discovered
that it was not nearly as important to know what they looked at as it was to understand
how they looked at it.
We developed certain groups such as revenue factors, earnings factors, return factors,
debt factors, cash factors, asset factors, trend factors, leadership factors, moating factors,
risk factors, defensive factors, innovation factors, response factors and many more, each
with its own set of relationships and its own unique weighting to other factors or elements
We knew that if we could identify some of these patterns, relationships and weightings,
we will to a large extent be able to predict what the "big players" are going to buy or sell
and if one can succeed in doing that it is almost impossible to go wrong with your
investments in the equity markets over the long run.
The results achieved by Valana during the past two years as demonstrated in the section
“Model Validity” on our website, Valana.co.za, more than vouch for the validity of the
Tips when starting a sensible and balanced share portfolio
The five-ten percent rule
There is a basic rule, or conventional wisdom, sometimes referred to as the five-ten
percent rule, which says that private investors should never have more than 5% of their
holdings in a portfolio in one single stock or 10% of their holdings in a single market
This, of course, is to enhance diversity so that one may avoid the risky problem of having
all your eggs in one basket when things really go wrong in the equity markets.
It basically means that there should be at least 20 stocks in a retail (private) portfolio and
that these should be spread over at least ten sectors of the market. Therefore, one should
probably not have more than two stocks in any single sector of the market.
Having a quality core
Ensure that at least one-third of your portfolio is invested in top quality jewel rated stocks.
Some current examples of such stocks will be:
¤ Altech ¤ Implats ¤ Pick n Pay
¤ Anglo Plc ¤ Massmart ¤ Remgro
¤ BHP Billiton ¤ Mr Price ¤ SAB Miller
¤ Bidvest ¤ MTN ¤ Sasol
¤ Grindrod ¤ Naspers ¤ Tigerbrands
The Valana model provides its members with the Jewel rating of all the companies
analysed by them during a specific year.
These are companies that have been around for a while and probably still will be with us
for a long time to come.
These companies also usually have a fairly good dividend and performance track record,
they are popular amongst institutional investors and pension funds, they have a strong
management team, may have global interests, a proven and sound business model, etc.
The effect of small trades
As most brokerage charges often operate on a sliding scale or they apply a minimum
charge per transaction, it is very important to let these parameters guide you in the size of
your transactions. For example, if the minimum charge per transaction is R250 and your
agreed to scale fee is 1%, any transaction under R25,000 will have the effect of pushing
up your actual scale fee. If you enter into a transaction of, say, only R5,000, the scale fee
will be 5% (250 as % of 5,000) and this will have an immense negative compound effect
on your eventual returns over time.
The different brokerage charges
Non-negotiable costs (Strate Settlement Fee, Protection Levy, Vat, Securities Tax, etc)
In a R30,000 buy transaction this will be R119.38 (0.38%)
In a R30,000 sell transaction it will be R44.13 (0.148% as tax does not apply)
Zero mandate (you make all the decisions ... scale fee is 0.4% to 1.5%)
Full mandate (broker trades on your behalf ... intermediation fee 1% to 3%)
Admin fees (trustee service, etc paid annually fixed at R500 to R1,000 per annum)
The basic difference between a zero mandate and a full mandate is that under a full
mandate you pay for the trading done on your behalf and the advice from the broker on
which stocks to buy or sell.
The question to ask yourself, of course is whether this advice is worth the price you have
to pay for it.
Wherever possible, one should align other cheaper resources in order to avoid paying
intermediation fees, as these transaction based intermediation charges can seriously
erode your eventual gains made on your stock market investments over time.
The impact of different stock broker mandates
Investors often underestimate the importance and impact of costs and expenses in their
Our research showed that many private (retail) investors do not even know what type of
mandate they have with their stock broker and they often cannot tell you what percentage
intermediation fee applies to their arrangement or agreement with their stock broker.
These charges are highly negotiable and depend on the size of your portfolio and the
services you require to be performed by your stock broker.
One should also not lose sight of the fact that most stock brokers are traders, believe it
their primary function is not to select winning stocks or manage a successful investment
fund, it is to trade as often as possible on your behalf.
After all that is how they make their money.
If at all possible, you should align other less expensive sources to assist you with stock
selection as even a 2% intermediation fee added to the other expenses could, over a
period as short as five years, result in you having to sacrifice more than 50% of your
If you use a credible source for stock selection you could do all your own trades via an
online broker facility which could bring your trading costs down to below 1% per
As most stock selection facilities have an annual subscription fee of around R1,500 per
annum this cost does not apply to each transaction and on an average portfolio of R1m
will only amount to 0.15% per annum (versus 2% per transaction that a stock broker may
Another big problem with giving your stock broker a full mandate is that they will, for
reasons already mentioned, trade much more often with your stock than you would.
In fact, they could turn around 25% of your stock each quarter.
The negative impact of this practice is dealt with in detail together with examples in the
last module where we deal with and provide illustrations of the "Tyranny of Costs".
The stock market is without any doubt the most effective asset class to enhance wealth
creation over an extended term, but only if one adheres to the tested rules and many trading
principles related to it.
In the next module we will be looking at some interesting characteristics of the stock market
that one should be aware of if you want to participate in and benefit from this exciting
20 October 2009