Category: Investor 101

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Investor 101

An Introduction to Technical Analysis

Technical Analysis is a technique or methodology for analysing securities with the primary goal to predict future price directions based on historical chart patterns.

Technical Analysis vs Fundamental Analysis

In finance most analysts group the techniques of security analysis into two broad categories: Fundamental and Technical Analysis. Whilst fundamental analysis focuses on the fundamental aspects of the actual company including its financial statements, earnings, balance sheet as well as market and sector environment, technical analysis predominantly focuses on the price graph of the stock. Many analysts, including Wise-owl, use a combination of Technical and Fundamental analysis in order to analyse and value securities.

This article is an introduction guide to technical analysis.

What is Technical Analysis?

As described above, technical analysis is a technique to analyse financial instruments such as shares, indices, ETF’s or any other security. The ‘technical analysts’ also known as ‘chartists’ mainly analyse the historical chart of a company’s stock and, based on certain techniques, attempts to predict the future direction of the stock price also referred to as the trend.

As opposed to Fundamental Analysis, the technique solely focuses on analysing the graph or chart of the stock and disregards fundamental information such as financial statements. The analyst attempts to identify certain chart patterns or trends within the stock’s graph, or any other graph, and conclusively makes predictions as to which direction the stock is likely to move. The only data needed for the assessment is the historical price data of the chart.

Technical Analysis is Based on Various Assumptions

Technical Analysis has been widely regarded as a tool or skill set that can assist an investor or trader in making investment decisions. Understanding the benefits and limits of Technical Analysis is an important step in order to become a better investor.
Technical analysis is based on several beliefs or assumptions. Some of the most common assumptions are:

Assumption 1: Stocks move in trends

A stock trend is a general direction in which the stock price is moving. The trend can be short, medium or long-term. Generally, stocks can either be in an uptrend, down trend or sideways trend.

Uptrend: An uptrend is when the general direction of the stock price is upwards. The best way to identify an uptrend is when the stock price creates higher peaks and higher lows. An uptrend is deemed broken if the latest low falls below the preceding low.
 

Downtrend: A downtrend is when the general direction of the stock price is downwards. The best way to identify a downtrend is when the stock price creates lower highs and lower lows. A downtrend is deemed broken if the latest high rises above the preceding high.

Sideways Trend: A sideways trend is when the stock price creates highs and lows at consistent price levels. A sideways trend is deemed broken if the latest high moves higher than the previous highs or the latest low moves below the previous low.

Assumption 2: Past performance is likely to repeat itself

Technical analysts try to find trends and base their forecast or conclusions on historic price movements of a stock. Based on these chart patterns coupled with the general assumption that history will likely repeat itself, they make investment decisions.

Assumption 3: The market discounts everything

Technical Analysis is based on the belief that every factor that impacts the stock price has already been taken into consideration by the market and thus is reflected in the graph. An analyst who purely focuses on technical analysis believes that the historical chart of a company provides all the information required to make future predictions. In their belief analysing the financial statements is not necessary as the market has already done that and has reacted accordingly.

Methodology of Technical Analysis

Chart

Charts are the bread and butter of Technical Analysis. Charts are used to identify and analyse patterns or trends in stock prices. Charts consist of a Y axis (vertical axis) and an X axis (horizontal axis). The X axis indicates the timeline, whereas the Y axis indicates the variable by which the security is measured, such as the price for a stock or points for an index.

Support and Resistance

Support and Resistance are important indicators in monitoring the trends of stock prices. In general terms, the ‘support level’ is a price level where a stock has consistently rebounded, this have ‘provided support’. A ‘resistance level’ is a price level where a stock has consistently failed to move past. A resistance level can be compared with a ceiling that the stock tries to break through, while the support level act like a ‘floor’.

Volume 

Volume refers to the number of shares traded during a particular period of time. This measure gauges the number of shares that traded hands for either a single stock, an index or an entire market. High volume provides greater liquidity, as more buyers and sellers are present. Generally speaking it is ‘easier’ to buy and sell shares if ther eis sufficient volume. It is often considered that it has greater signficance for a stock if it moves up or down in a high volume session, than its movements in a low volume session.

Oscillators

Oscillators is a collective term used for indicators in technical analysis. These indicators often have a set minimum and maximum level that provides analysts with information regarding the current state of the stock. When a stock hits the minimum level, it is often considered oversold and vice-a-versa. Some of the most common oscillators used are Moving Average Convergence Divergence (MACD), Price Rate of Change (ROC), Relative Strength Index (RSI) and Commodity Channel Index (CCI). 

Moving Average

Many traders use the moving average as a tool to find the right entry point to a stock. Some of the most common types of moving averages are:

a. Simple Moving Average: This method calculates an average price of a stock in the past ‘n’ trading days. This method just calculates average prices and results in a simple average line by giving equal weighting to old and new data/prices alike. This method is best to gauge the strength of a long-term trend. The SMA can show if a stock is currently trading above, below or in line ith its average price.

b. Exponential Moving Average: This moving average method places higher weighting to the most recent data and hence can be a more accurate measure to measure short-term trend patterns.

Technical Analysis: Common Chart Patterns

Apart from a basic continuation trend – where the stock forms higher highs and higher lows – there are several chart patterns that indicate – in technical analysis – either a continuation or reversal of a trend. We have summarised some of the most common chart patterns below.

Head and Shoulders

The head and shoulders pattern usually indicates the reversal of a trend. This pattern can be seen when a stock rises to a peak (left shoulder) and drops, then rebounds and rises higher than the previous peak (head) and declines again. Finally, the stock rises again, but lower than the second peak and drops again (right shoulder).  A neckline is formed by connecting the points where the stock has been rebounding. Once the head and shoulder is formed, the technical analyst believes that the stock will likely reverse its trend. The example described above, the next move will likely be downwards. A ‘Head and Shoulders’ patterns can also be seen as a reversal patterns of a downtrend.

Double Top

This a bearish reversal pattern which is made of two consecutive peaks with a moderate trough in the middle. The peaks are roughly equal and the trend resembles the letter M.

Double Bottom

This is a bullish reversal pattern which is made of two consecutive troughs with a moderate peak in the middle. The troughs are roughly equal and the trend resembles the letter W. 


Ascending Triangle

An ascending triangle is seen during the continuation of an uptrend. This is a bullish chart pattern and can be recognized with the help of two trend lines. One trend line connects a series of higher lows and another trend line that connects the highs and has proven to be a strong resistance level. This shows that the stock is consolidating after a previous uptrend and once the stock breaks above the resistance, we will likely see a continuation of the uptrend. The move past the top trend line is often called a ‘breakout’.
 

Descending Triangle

This is a bearish chart pattern created by connecting a series of lower highs with a second trend line that connects a series of equal lows which has proven to be a strong support level. Once the stock breaks below the support level we will likely see the stock moving in a downtrend.

Symmetrical Triangle

A symmetrical triangle is usually a result of consolidation and often represents market indecision. An attempt to push the stock higher through buying is met equally with attempts to pull the stock lower through selling. This action makes the stock move in the shape of a narrowing triangle forming an apex, often trading in low volumes. Technical analysts will wait until the stock breaks either to the up or downside which is called the breakout. The stock then tends to move in the same direction as the breakout.

Conclusion & Comments on Technical Analysis

Technical analysis is a useful tool that can complement your fundamental research and can assist investors and traders alike in making investment decisions. However, you need to be aware of the possibilities as well as limitations of technical analysis. At Wise-owl we use Technical analysis only as a supporting method as it helps us to backup our fundamental research or to determine entry or exit points.

As the markt is aware of the most common chart patterns we will often witness the so called ‘self-fulfilling’ chart patterns. This means that e.g. a breakout occurs as the entire market anticipates the next move and acts accordingly.

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Investor 101

What is the Purpose of a Share Buyback and How can Shareholders Benefit from it?

What is the Purpose of a Share Buyback and How can Shareholders Benefit from it

US companies in the S&P 500 have spent over U$135 billion on share buybacks during the fourth quarter of 2015, representing a 5.2% rise year-on-year.  Consumer technology giant Apple Inc. (NASDAQ: AAPL) topped the list, spending U$6 billion on repurchasing its own stock. Share buybacks are very common in Australia too. Local pharmaceutical company CSL Limited (ASX: CSL) announced a share buyback program of $1 billion in October 2015. The number of buybacks has risen substantially since the GFC and some investors may be confused and wonder what the purpose of a buyback is, why companies buy their own stock, what the impact on the share price is and how shareholders benefit from a buyback.

What is a Share Buyback?

As the name suggests, a share-buyback or a share repurchase refers to the process when a company re-acquires its own stock or, in other words, the company buys shares back from its shareholders. in Australia, the Australian Securities & Investments Commission (‘ASIC’) as well as the Corporations Act 2001, layout a number of rules and regulations for buybacks.

Why Companies Consider Share Buybacks

With an increasing number of companies announcing buybacks, it appears that directors believe that buybacks have a positive impact on the business as well as shareholders. Listed below are some of the most common reasons why a company might repurchase its own shares: 

  • Take Advantage of Undervalued Share Price: 

    A common scenario for a share repurchase is when management believes that their own shares are ‘undervalued’. Rather than keeping surplus cash in the bank, management decides to purchase shares of the company at – what they believe – a ‘cheap’ price. The buyback has two effects on the company’s stock: On the one hand, the number of shares outstanding is being reduced (we will go more into detail below) and buying pressure increases as the company is physically buying its own stock. On the other hand, by buying (often) millions of dollars of its own stock, management also reassures the market that they are confident in their own business operations, which encourages investors to buy. The market thinks that management would only buy their own stock if they believe that the value per share will increase in the medium to long-term.
  • Reduce Dilution and Increase Ownership:

    Over time companies tend to issue new shares, e.g. via capital raisings or exercise of options, which implies dilution of existing shareholders. By buying back stock, a company can reduce the impacts of dilution. Also reducing the number of shares outstanding may help increase ownership of the company’s management.

  • Enhancing Financial Ratios:

    While enhancing a company’s ratios might not be the sole reason for repurchasing shares, it is often an attractive by-product of these transactions.

    Reducing the number of shares outstanding can have a positive impact on various ratios that are tracked closely by the market.

    • Return on Asset (ROA): This ratio is calculated by dividing a company’s net income by total assets. Reducing the share capital reduces a company’s total assets and overall has a positive impact on the ROA.
    • Return on Equity (ROE): Return on Equity is expressed as the amount of net income returned as a percentage of shareholders’ equity. Hence, if a company’s earnings remain constant, reducing the total equity lifts its ROE.
    • Earnings Per Share (EPS):  This ratio is calculated by (net income – dividends on preferred stock)/ average outstanding shares. Hence reducing the overall outstanding shares boosts the EPS of a company.

How do Shareholders benefit from a Buyback?

A share-buyback is a capital management strategy that is often seen as a benefit or reward to shareholders. While investors clearly benefit from dividends, as money is deposited directly into the shareholder’s bank account, the benefits of buybacks are indirect.  As we can see from the aforementioned factors, lowering the number of shares outstanding ultimately helps to increase the share price. The company returns cashback to its shareholders and also gives investors the opportunity to capitalise on their investment. Management shows confidence in their own company which may enhance market sentiment towards the stock.

There is obviously no guarantee that the buyback will result in net capital gains as the price of a company’s stock depends on a variety of factors. However, buybacks are often considered an attractive way to invest surplus cash whilst boosting investor confidence.

When are Buybacks Not in the Best Interest of Shareholders?

While buybacks might be a sensible way for companies to use extra cash, however, in some cases, a buyback might not be in the best interest of shareholders. Listed below are a few scenarios when a share repurchase might hurt shareholders.

  • If a share repurchase is made when the company’s shares are already overvalued, management is not making the best use of the company’s cash. According to Factset, Apple paid a 13% premium to buy back its shares during the fourth quarter. Buying back stock ‘for the sake of it’ may have an adverse impact.

  • In some cases, when borrowed money is used to buyback stock, it can hurt the company’s ratings. Borrowing money for the purpose of share repurchases might drain a company’s cash reserves, which could otherwise be used during tough times.

  • Using surplus cash for purchasing its own shares might also indicate that the company’s management has no better option to invest surplus cash and the market may be disappointed as there are better opportunities elsewhere.

Conclusion

Share buybacks can be an efficient way for management to boost the company’s undervalued share price and reduce dilution, but they also allow management to show confidence in their business operations. However, as briefly outlined above, not every buyback automatically benefits shareholders. Hence it is important for investors to gauge the timing and purpose of a buyback and also look at the overall financial situation of the company.

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Investor 101

How to Open a Share Trading Account

How to Open a Share Trading Account

A study from the ASX showed that over 2.5 million Australian non-investors were very keen to invest but had little knowledge on how to go about it and were confused by the information overload on the internet and in the media.

Investing in shares has historically been a great source to generate income and grow your wealth, but before getting started, you need to make sure that you know what you are getting yourself into. Before you open a share trading account you need to decide if you want to invest in shares and ensure that you understand the risks associated with investing.

Here are a few education articles that may assist you prior to making a decision:

  • What are shares? 
  • What are the risks of investing in shares?

Once you understand the terminology and risks and you have decided to begin your investing journey, it is time to open your share trading account. You have to open a share trading account with a registered broker, who will buy, sell and hold shares on your behalf. This article will address the role of the broker, the different types of brokers available, and briefly outline the process of opening a share trading account.

The Role of the Stock Broker

In Australia it is mandatory for investors to go through a broker to buy or sell shares on the stock market.

A stock broker is a financial agent who buys and sells securities on behalf of their clients. The broker acts as an intermediary between investors and the stock exchange, and charges a ‘brokerage fee’ for this service.

Even though many picture the traditional broker as a person, the term technically refers to the company with the registered license number. Thus the term ‘stock broker’ could refer to a company, a person or even just an online platform.

Full Service or Non-Advisory broker?

Historically stock brokers have always been full service ‘premium’ brokers who called their wealthy clients to execute trades on their behalf. The role of the broker was not just limited to the basic ‘execution service’, but also to provide financial advice on top. However, with the internet came an increasing number of non-advisory, online or discount brokers to the market. Before you open a share trading you need to decide what type of broker is most suitable for you.

Full Service Broker 

A full service broker generally offers comprehensive advice on buying and selling securities, provides research and tailored investment advice. Before executing a trade, the broker may also advise on the soundness of the investment. A full service broker typically charges a higher brokerage fee due to the wide range of services provided, however some broker may charge more competitive rates than others.

The full service broker is traditionally used by investors who enjoy having the ability to talk to someone, have trades executed on their behalf or even have their share portfolio managed by a finance professional.

Non-Advisory or Online Broker

As the name suggests, a non-advisory broker is predominantly used to execute trades and generally does not provide any advice on specific investments. This broker is also called a discount or an online broker.

Usually, non-advisory brokers charge lower fees and clients have to place buy or sell orders themselves. Investors are required to keep an eye on their investments and act when they believe it is appropriate. Most investors who make use of an online broker conduct their own stock research or pay a third party, such as Wise-owl, to provide complimentary research.

58% of Australians Trade Online: Study

A research report released by the ASX showed that 58% of Australian investors chose online brokering facilities, while only 31% of investors chose a full-service broker or advisor. It appears that a growing number of Australians have the desire for self-direction and control over investments.

How to Apply for a Share Trading Account

Before applying for a share trade account, an applicant must ensure that he satisfies all the requirements outlined below:

An applicant must be at least 18 years of age, have an Australian residential and postal address, and – in most cases – also have a valid email address and mobile number. During the application process the applicant has to provide a number of personal details and comply with the Anti-Money Laundering and Counter-Terrorism Financing Act 2006.

Application process:

Listed below are the main segments of a share trading application form. However, please note that the steps may vary slightly depending on the broker of your choice:

  1. Applicants are required to decide on the nature of the account:
    • Individual account: Account in your personal name
    • Joint account: Account in the name of you and someone else, e.g. your partner
    • SMSF: If you wish to apply on behalf of your Self-Managed Super Fund
    • Trust: If you wish to trade as a trust. Example: family trusts, trusts for minors, settlement trusts, and charity trust
    • Company: Trade as a company’s director or secretary on behalf of a company.
  2. The applicant is required to provide personal details, residential address, and his Tax File Number (TFN). In this step, the applicant might also be required to disclose his citizenship status, SMSF, or trust details.  Please note that additional documentation may be required for SMSF, Trust, and Company accounts.
  3. In order to open a share trading account, applicants are required to pass the identity check. Most Australian citizens and residents can be verified online, however, some applicants may be required to provide proof of identity manually (online, in person, or by post). If the applicant sends copies, he/she is usually required to get these documents certified by an eligible person (e.g. a justice of the peace, attorney, etc).

    Please note that several documents may be required for identification, however, the broker will usually advise of the requirements during the application process. It usually a requirement to provide a minimum of 100 points of ID. Documentation includes e.g. Australian Drivers Licence, Medicare Card, Australian or Overseas Passport, Australian Birth Certificate
  4. Investors need to nominate a bank account for withdrawals or dividend payments from their share trading account. 
  5. Once the application is approved you need to fund your account by making a transfer from your cash account to your new share trading account. 

Next Steps: Buy and Sell Shares

As soon as your share trading account is approved and fully funded, the next step is to buy shares and start building your portfolio. Here are some articles that may further assist you along the way:

  •  How to buy and sell shares
  • How to build a share trading portfolio
  • Investing in international shares
  • How to invest in the NYSE or NASDAQ

If you have any additional questions please do not hesitate to contact the analyst at Wise-owl on 1300 306 308 or use the live chat on the website.

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Investor 101

How to Lookup ASX Announcements

How to Look up ASX Announcements

According to Listing Rule 3.1 under the Continuous Disclosure Obligations laid out by the ASX, any company that is listed on the ASX has to disclose company news in the form of ‘ASX announcements’. The rule states that all information that a layman might expect to have a material effect on the company’s share price, have to be released to the market immediately.

Why Look Up ASX Announcements?

Investors search for company announcements for various reasons. When you do your own research, we advise you to go through a company’s announcements to understand the company’s history, balance sheet, corporate activity, or one-off events. Unless you buy a stock for technical reasons (read here our introduction to technical analysis), you’ll have to understand the company’s business model to a certain degree and the announcements are a good place to start. As the ASX keeps a record of all announcements, you will also be able to compare the historical financial performance for any given period. Another reason to look up a company’s announcements might be to find out why a stock you are holding has made a significant move to the upside or downside. Significant share price movements are often linked to price-sensitive announcements.

Many average retail investors might be confused about finding relevant factual data about the companies they are interested in. They might finally resort to reading the business section of the major tabloids or check the company’s website as an avenue for updated information.  However, the newspapers are sometimes limited in nature, often reporting on only the major ‘blue-chip’ companies or including personal opinions in the article. Investors who are doing their own research might be overwhelmed by the numerous opinions on the web.

3 Ways to Look Up ASX Announcements

Find below a few options of where to search and find ASX announcements.

1. ASX Website
Many investors are unaware that they can keep themselves updated about operational changes of any ASX listed company. This information isn’t difficult to obtain, as everyone can access it by simply navigating to the official ASX website www.asx.com.au. They can search for the information of any ASX company of their choice and view past company announcements. The ASX website is the best place to look for announcements as they are released in real-time.

Today’s announcements can be found here: http://www.asx.com.au/asx/statistics/todayAnns.do

The website automatically displays the latest announcements, sorted by the time of publication. Simply save this link in your web browser so you can access it whenever you want. In order to view new announcements, you have to refresh the page regularly.

Additionally, the ASX website also denotes to the reader the ‘price-sensitive announcements’ indicated by a red ‘$’ beside the announcement. These announcements are usually more important, and could potentially have a substantial impact on the company’s share price.

These ‘price-sensitive announcements’ vary in nature. They could be the release of earning results for a given time period, the appointment of a new CEO or a director, or some unforeseen event occurring within the business’s operations (such as BHP’s recent Samarco Dam Disaster).

Historical announcements of a particular company can be found here: http://www.asx.com.au/asx/statistics/announcements.do

Simply choose the ticker code of the company you want to look up and select the timeframe. Tick the second box and select “2016” if you want to see all announcements released in 2016.

View the screenshot below for illustration purposes

Image: Screenshot of the search function for company announcements. Source and credit: www.asx.com.au

2. On your Broker’s Website
Many online brokers have built-in features to view and read company announcements. The largest online brokers in Australia usually have a section dedicated to announcements in their membership portal. If you can’t find this section or you are unsure if your broker offers this feature, we advise you to talk to your broker and find out if and where you can read company announcements. Often there is a 20-minute delay with these publications.  

3. On the Company Website
Every listed company has a section on its website dedicated to investors. You can read media released stock information, annual reports, key dates, or the “Corporate Governance” statement. Jump onto www.google.com.au and type in the name of the company you are looking for. Usually, the first result is the company website, and from there you should be able to find all announcements.

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Investor 101

What Are Dividends? –Dividend Definition and Basics

What are Dividends Dividend Definition and Basics

A dividend, also known as distribution, is a portion of a company’s profits that the company may decide to distribute to its shareholders. Dividends are usually a percentage of a company’s earnings, which is called the dividend payout ratio.

To understand the concept of dividends, one must thoroughly understand the concept of shares. Purchasing a share in a particular company entitles ‘shareholders’ to ownership in the company and therefore entitles them to receive dividends.  Click here to learn more about shares.

Whilst many companies, especially established companies with earnings, elect to pay dividends, a public company is not obligated to do so. It is often seen that large and established companies distribute dividends, while the smaller companies focus on retaining their earnings in order to grow their business.  It is at the company’s discretion to either retain its profits for reinvestment purposes or distribute dividends to its shareholders as a reward. One of the most famous examples of companies that do not pay dividends is Alphabet Inc. (NASDAQ:GOOGL), the parent company of the search engine Google, which has to date (Feb-2016) not paid a single dividend to its shareholders.

Types of Dividends

The most common type of dividend used is the cash dividend whereby the company pays a certain amount of dividend in cash. However the company may also choose to pay a ‘stock dividend’ whereby it issues common shares to its shareholders without any consideration.

Most of the ASX listed companies distribute dividends twice a year, which are called the ‘interim’ and ‘final’ dividend. ‘Special’ dividends may also be distributed if the company posted exceptionally strong earnings and decides to reward shareholders.

Reasons for Paying Dividends

Companies that distribute regular dividends over a long period of time, are often considered as ‘reliable’ or ‘stable’. It is often seen that a company’s stock price increases if the company pays dividends as it provides investors with a reason to buy. If companies have paid dividends in the past and decide to reduce or even stop paying dividends, they may experience a decline in the overall value of the company.

Reasons against Paying Dividends

Some analysts believe that companies who do not pay dividends, but rather reinvest surplus cash into the business, will increase the value of the firm more rapidly. An alternative to paying dividends may also be firms deciding to repurchase their own stock, which reduces the amount of shares outstanding and results in buying pressure for the stock. In reality, companies often decide to do both.

Who is Eligible to Receive Dividends?

Generally, every holder of a company’s security or common stock is entitled to receive a dividend. Preferred stockholders are entitled to fixed dividends for as long as the company remains profitable and generally receive dividends before common stockholders. Mutual funds and ETF shareholders may also be entitled to receive dividends, however it may vary depending on the conditions of the security.

Terminology: Dividend Dates, Dividend Yield, Franking Credits

1. Dividend dates: There are four important dates investors should be aware of:

a. Record Date: The date when the company determines which shareholders are eligible for the dividend payment.

b. Ex-dividend Date: in Australia the ex-dividend date usually occurs two business days before the record date. It is very important to note that an investor must have purchased the shares before the ex-dividend date in order to be eligible to receive the dividend. On the ex-dividend the stock price usually decreases by the amount of the dividend.

c. Cum dividend: This refers to the period before the ex-dividend date. Hence, if shares are bought during the cum dividend period, investors are entitled to receive the upcoming dividend.

d. Date Payable: This is the date on which the dividend is paid to shareholders.

2. Dividend Yield: The Dividend yield is the dividend expressed as a percentage of the current share price of a company. For example if the company’s stock is trading at $100 and the company distributes a dividend of $5, the dividend yield is 5% ($5/$100). Stock prices and net dividend payments are often not comparable as the value per share depends on the total amounts of shares outstanding, hence a percentage figure is a more accurate way of analysing the size of the dividend.

3. Franking credits: This is a type of tax credit, also known as imputation credit, that allows Australian companies to pass on tax benefits to its shareholders, as the company has already paid tax for its earnings. The credit can be used to reduce income tax paid on dividend.

Where to find Upcoming Dividends:

Wise-owl subscribers can view upcoming dividends in the ‘Dividend Calendar’ in our member’s portal. Existing members may log on here and visitors can sign up for a free trial here.

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Investor 101

Is there a Correlation between GDP Growth and Stock Market Returns?

Is there a Correlation between GDP Growth and Stock Market Returns

The correlation between economic growth and stock market returns is a recurring question amongst analysts and investors alike. While many claim that ‘theoretically’ both figures should be the same, others believe that there is no correlation at all. In this research piece we will address some of the most common assumptions and observations. However, please note that the complexity of this issue is high and this simplified approach may not entirely provide an adequate comparison of these two variables.

GDP Growth = Stock Market Returns?

In a theoretical environment stock price increases should exactly match real GDP growth. The underlying economy of a country translates into a company’s profits, thus into Earnings per Share (EPS), which eventually determines the price of a company’s stock. However, this only works if a country’s economy is closed, valuations remain constant and if only domestic companies are listed on a country’s stock market. As we know the world economy isn’t ‘theoretical’, hence this example may not be an appropriate comparison, however understanding the basic principles of stock market returns is crucial for this experiment.

Theoretical versus Real Economy

Studies have shown that in many countries there is somewhat of a correlation between GDP growth and stock market returns. In theory, and over the long-term, aggregate corporate earnings rise when the economy grows or vice versa.

However, there are plenty of examples where the stock market was clearly disconnected from the real economy. Looking at shorter timeframes, we note dramatic variations of the two key variables, especially in times of significant volatility. During the 2008 Financial Crisis (‘GFC’), stock markets around the world plummeted approximately 40-60%, but of course, the real economy did not shrink ~50% within a few months. The following bull market saw the S&P 500 nearly triple in just 6 years, which is also not reflective of real GDP growth.

However if we are looking at a longer timeframe we note a more ‘moderate correlation’, albeit still not perfect. Over the past 50 years the US economy expanded at an average compound rate of between 3%-3.5%, however the past 10 years have been significantly slower with average GDP growth less than 1.5% according to data provided by the World Bank. Between December 2006 and December 2014, the US benchmark index S&P 500 gained 45%, an average simple growth rate of 5.6%, four times higher than the average growth rate of ~1.5%. So why are there still such discrepancies between the two key variables GDP growth and stock market returns?

Reasons for Disproportionate Returns

Both sets of data have expanded over the long-term indicating that GDP growth can generally be considered to be a driver for the US stock market. However as noted above, the US stock market has outperformed GDP growth in the past 10 years. In the real economy there are several factors that cause disproportionate returns, which is why GDP growth and stock market returns are not an ‘exact match’.

Several factors that cause these discrepancies include but are not limited to:

  • Valuations are Volatile: The market determines the value of a company and various components may influence these valuations, e.g. sentiment, confidence, emotions
  • Expectations: Expected economic growth may already be built into the prices and thus reduces future realised returns
  • Dilution: New share issuances dilute return on equity for existing investors, therefore capital growth may be lower than growth in corporate earnings
  • Dividends: Stock market valuations may be impacted by a company’s willingness to pay dividends. Not paying a dividend could result in a stock trading at a discount to its ‘net value’ and vice versa
  • Globalisation: In today’s day and age it makes more sense to look at global, rather than local markets. A company may produce parts of its business outside of the country it is listed and parts of its profit could be earned outside via overseas sales. Parts of the production process for a multinational firm are not reflected in the country’s GDP.
  • Impact of Central Banks Policies: In recent times the role of central banks and their monetary policies have significantly impacted stock market returns. The most recent example was the ‘quantitative easing’ policy of the Federal Reserve Bank (FED).
  • Exclusion of Private Sector: Stock markets only track the performance of listed companies. While these companies are typically the largest companies of a country and have the strongest weighing on the economy, private companies or sectors which contribute to a country’s GDP are excluded from these returns.
  • M&A Activity: Mergers and acquisitions often result in significant returns for shareholders, while the impact on the real economy is often less significant.
  • Influence of Politics and Media: Both politics and media may have a significant impact on stock market valuations and market sentiment. Especially in countries where the media is state-owned and news may not be ‘factually correct’, we usually tend to see greater discrepancies than in markets with less government impact. 

Do you know any other factors that cause real GDP growth to differ from stock market returns? Please leave a comment for our investment community.

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Investor 101

Common Share Market Terminology for Beginners – Part 2

Common Share Market Terminology for Beginners Part 2

Share Market Terminology for Beginners – Part Two

Find below some of the most common share market terminologies explained for beginners. Click here to read part 1 of the Wise-owl Share Market Terminology series.

Margin Account:

A margin account allows investors to trade on borrowed funds. This service is usually offered by brokerage firms. Similar to a mortgage loan, shares that are bought on credit are used as collateral, and interest is charged periodically.

Market Capitalisation:

Market Capitalisation is the total market value of a company. It is calculated by taking the company’s total shares outstanding and multiplying it by the current stock price. As the market value of the stock regularly changes, so does the company’s market capitalisation. Among other things, the market capitalisation of a company is an important factor in qualifying for the main indexes such as the ALLORDS or ASX200. Companies with a market cap of less than $3bn are often categorised as small to mid-cap stocks. For more information on small and mid-cap investing read Investing in Small Mid-Cap Stocks.

Market Order:

A market order is placed through a broker to buy or sell a stock immediately at market value or the best available price. The order is likely to be executed as it doesn’t contain any restrictions. Market orders are generally only recommended for high volume stocks, as buying stocks with low liquidity (low traded volume) through ‘on market’ could result in a large spread.

Ordinary Share:

The most common type of share is an Ordinary Share, also known as a common share. An ordinary share represents equity ownership in a company, carries one voting right per share, and is usually eligible for dividends. Should a company wind-up and distribute its assets, ordinary shares are the last in line behind bondholders and preferred shares.

Preferred Share:

There are different types of preferred shares with different characteristics, however, as a generalisation, preferred shares are a combination of debt and equity. Preferred shares are entitled to assets and dividends ahead of ordinary shares and usually have a fixed dividend rate. Preferred shares have voting rights, however, are usually restricted to specific circumstances or particular resolutions.

Price-Earnings Ratio:

The price to earnings ratio, also know as the P/E ratio, is a multiple that indicates how much investors are willing to pay in order to receive one dollar of the company’s earnings. It can be calculated by Market Value per Share/ Earnings per Share. The higher the PE ratio, the more the investors are willing to pay for its future earnings and vice-a-versa. This ratio is also called the price multiple or the earnings multiple.

Rights Issue:

When a company wants to raise extra capital (e.g. to pay off its debt or expand its operations), it can choose to offer a rights issue. Through this method, the company can issue rights to existing shareholders with the right, but not the obligation to buy additional shares. The price at which the new shares are offered comes usually at a discount to its current market price. The number of additional shares is set on a pro-rata basis, whereby an investor can buy shares at a certain proportion of his/her holdings.

Risk-Reward Ratio:

The risk to reward ratio is a measure that indicates the amount of risk an investor has to take for every dollar earnt. This can be measured through indicators like alpha, beta, Sharpe ratio, and r-squared. Alpha measures the return on investment against a market index. The beta measures the risk on investment compared to a market index. The Sharpe ratio measures the excess average return earned over the risk-free rate for every unit of volatility. R-squared is a measurement of each stock’s movements in comparison with a market index as a benchmark.

Standard Deviation:

The statistical tool standard deviation is used as a risk measure and is also known as historical volatility. The Standard Deviation is calculated by finding the square root of a portfolio’s variance. A portfolio’s variance measures the divergence of a stock portfolio’s returns from a certain index.

Stop Loss Order:

When an investor buys a stock, a stop-loss can be put in place to protect a certain position from downward movements of the security. The stop order instructs the broker to automatically sell the stock if it reaches a certain price. The stop-loss is designed to limit the investor’s loss if the stock declines. For example, if an investor purchases a stock for $1.20, a stop-loss can be put in place to automatically sell the stock if falls to $1.00, thus limiting the investor’s loss to $0.20 per share. A stop-loss can take the emotion out of the selling process or be useful if the investor needs to spend some time away from the stock market.

Technical Analysis:

Technical analysis is a technique of stock analysis that generally analysis historical price patterns in a stock price graph. This method uses the historical performance of a stock to predict its future trajectory. ‘Technical analysts’ look for specific technical patterns in a historical price graph. It usually does not attribute much weighting to the fundamentals of a company, index, or market.

Technical Breakout:

The term ‘breakout’ is usually used in technical analysis and refers to a technical pattern when a stock’s price moves higher than its resistance level. At this point, the stock often experiences higher volumes as it is considered a bullish sign amongst technical traders. traders assume that stock continues to trade higher after breaking out of its resistance level.

Volatility:

Volatility is the divergence or variation of stocks and indices from an expected level. The divergence can be upward or downward depending on supply and demand from the market. Volatility also measures a security’s stability as higher volatility generally implies higher risk. 

Yield:

Yield usually refers to the income received from an investment and is often used in conjunction with dividends or distributions. While dealing with stocks, the term ‘yield’ is often used interchangeably with ‘dividend yield’. A dividend yield is expressed in percentage terms and indicates ‘how much’ dividend was earned for the price paid on each share. The annual yield is calculated by ‘Annual Dividends Per Share/Price Per Share’.

Click here to read part 1 of the Wise-owl Share Market Terminology series.

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Investor 101

ASX 200 Explained – What is the ASX 200?

ASX 200 Explained What is the ASX 200

What is the ASX200?

The abbreviation “ASX” stands for Australian Securities Exchange, which is the primary exchange for Australian stocks based in Sydney. The “ASX200” is a benchmark index that was created in the year 2000 and consists of the 200 largest public companies by market capitalisation listed on the ASX. As with all indices, the ASX200 is measured in points and tracks the combined movements of all 200 stocks within the index. Daily changes to the index are measured in points or percentages. The ASX200 performs quarterly rebalances, where the index adds and removes firms that have qualified or no longer qualify as ASX200 companies using the previous six months data.

How does a company qualify for the ASX200?

To be included in the ASX200 a stock must satisfy three conditions:

  • The stock must be listed on the Australian Securities Exchange as an ordinary or preferred stock.
  • The stock must satisfy liquidity requirements. Liquidity basically means how often the stock is traded and at what volume, indicating how easily an investor can buy or sell the stock. For the ASX200, the stock must have a certain level of liquidity, however the liquidity cannot be dominated by a small group of investors.
  • The stock’s float-adjusted market capitalisation must also satisfy the requirements of the index. In the ASX200 that generally means that the company’s float adjusted market capitalisation must be amongst the 200 biggest on the ASX. The market capitalisation cannot include large strategic holdings or issuing of new shares.

Note that these three conditions are required for inclusion into the ASX200, however if an existing ASX200 company falls outside of the conditions temporarily, it does not mean that it is immediately excluded from the index. The index is rebalanced quarterly.

What is the ASX50, ASX100 and ALLORDS??

The ASX50 is made of the top 50 largest companies on the ASX, the ASX100 is made up of the top 100 and the ALLORDS is made up of the top 500, as measured by float-adjusted market capitalisation. As with the ASX200, the ASX50 and ASX100 both focus on market capitalisation, and liquidity. The ALLORDS focusses only on market capitalisation and does not consider liquidity. All indices are rebalanced quarterly, using the previous six months data.

What is the sector make-up of ASX200?

The ASX200 is made up of 10 sectors, Energy, Materials, Industrials, Consumer Discretionary, Consumer Staples, Health Care, Financials, Information Technology, Telecommunication Services, and Utilities.

Image Source: Standard & Poor’s

The index has 10 sectors however is significantly dominated by two, Financials and Materials. Financials alone make up approximately 47.2 per cent of the index and include companies such as the major banks. The Materials sector makes up 14.5 per cent and include companies such as BHP and Rio Tinto.

How to invest in the ASX200?

Investing in the AX200 can be done simply by buying shares in any ASX200 listed company through a broker. For more information on buying shares read How to Buy and Sell Shares.

An investor can also invest in an Exchange-Traded Fund (ETF), which tracks the ASX200 as a whole and is traded like a common stock. ETF shares can be bought through your broker as with any common stock. Before buying into an ETF, investors need to consider the ASX200 sector makeup, as movements in the financial or material sectors for example, may have significant impacts on the value of the ETF.

Investing in the ASX200 can also be done via a fund manager. The fund manager can provide exposure to specific ASX200 stocks or exposure to ASX200 Index funds that track the ASX200 as a whole. Investors need to consider management fees before investing with a fund manager.

The ASX200 also offers the option to trade future contracts on the index. ASX200 future contracts can be bought or sold through any participating brokers such as CMC Markets or Intelligent Financial Markets. Future contracts can be bought for varying durations and can be sold before or at maturity. Future contracts do not require full payment upfront, rather an investor need only pay an initial margin, making futures generally a cost effective way to trade the ASX200.

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Investor 101

Investing in Small and Mid-Cap Stocks

Investing in Small and Mid-Cap Stocks

Investing in small and mid-cap stocks can be profitable, exciting, and help you to diversify your portfolio. Read below for a full guide about small-mid cap stocks, advantages and risks, and some useful tips on how to analyse these high growth companies.

What are Small and Mid-Caps?

Whilst there is no regulated definition as to which companies classify as small or mid-capitalisation stocks, there are a few guidelines that help determine if a company belongs into this category. There are many ways to categorise stocks by its size and one of the most used benchmarks is a company’s market capitalisation or also known as market cap. The market cap can be calculated by multiplying the company’s current share price by the total amount of shares on issue, also known as ‘shares outstanding’. The market cap is the total amount at which the market values the company.

Another factor to take into consideration is the stage of the business at which the company is at. Is the company in the growth or production stage of the business or maybe even still in exploration (for miners)? Is it reliant on external capital? Does the company generate positive cash flow yet?

Taking into account all these factors coupled with the implied market cap, helps you determine if the company is a small or mid-cap stock. There is no common definition and different markets have different benchmarks depending on the individual characteristics of the economy, the country or the size of the market just to name a few.

Small-Caps

As per Wise-owl’s definition small caps in Australia have a market cap of typically less than $400 million. However the S&P/ASX Small Ordinaries Index, which represents the smaller members of the ASX, has companies included that range from around $10 million to several billion. The average size of the market cap is somewhere around the $400 million mark.

Mid-Caps

Australian mid-cap stocks with advanced business operations are often being referred to as the stocks on the S&P/ASX 200, not including the leading 50 companies on the S&P/ASX 50. The average market cap of mid-caps is somewhere between $500 million and $3bn whilst some may be valued as high as $7bn.

Fine line between Small and Mid-Caps

At the lower end of the chain there is sometimes a fine line between small and mid-cap stocks and some of the criteria may overlap. In some instances, a company with a smaller market capitalisation may fall into the higher category as its business operations are more advanced than those of a company with a bigger market cap. Due to the similarities small and mid-cap stocks are often being put in the same group and commonly referred to as ‘Growth Stocks’.

What is the Difference to Large Cap Stocks?

In Australia large capitalisation, large-cap or sometimes ‘blue-chip’ stocks are the largest companies listed on the Australian Securities Exchange (ASX). Most research firms classify the largest 50 companies by market cap as large cap stocks, which can be found in the S&P/ASX 50 index. Those companies have a median market cap of between $5bn and $50bn. The largest company on the ASX by market cap is currently Commonwealth Bank of Australia (ASX:CBA) with a market cap of more than $100bn as of September 2015.

Common characteristics of large cap stocks in Australia are:

  • Long-lasting and established business operations
  • Consistent and reliable dividend payments to its shareholders
  • High liquidity
  • Media coverage and interest of the general public
  • Often considered as ‘safe’ or ‘less risky’

Why Invest in Small and Mid-Cap Companies?

Investing in small and mid-cap stocks may have several advantages or disadvantages for your portfolio. Depending on your personal situation and your willingness to take risk, you want to consider to diversify away from large-caps and to allocate a certain portion of your portfolio to small and mid-caps. There is no rule and definite answer as to which ratio is correct. A conservative investor could potentially have 80-90% in large caps and 10-20% in small and mid-caps, while a more aggressive investors could increase his/her interest in small mid-caps to 40-60% or even more. If you want to determine the right strategy for your portfolio, we recommend you talk to a financial planner or feel free to give Wise-owl a call on 1300 306 308.

Here are some of the common advantages and disadvantages/risks:

Common Advantages

  • Often greater potential for capital growth
  • Less affected by macroeconomic turmoil
  • Takeover targets
  • Management’s actions have great impact

Common Disadvantages/Risks

  • Often higher risk profile
  • Often reliant on external capital
  • Low liquidity may complicate transactions
  • Many small-caps don’t pay dividends

A Guide to Investing in Small and Mid-Caps

As soon as you are aware of the risks and rewards associated with investing in small and mid-caps, we recommend that you determine a basic strategy and stick to it. Keep in mind that every investor has different goals and expectations and individual circumstances which may affect the strategy. The following questions may help you determine an appropriate strategy:

  • How much am I willing to invest in small and mid-caps?
  • What’s the relative weight on my overall portfolios? (e.g. 10%. 20% or 40%)
  • How many individual positions do I want?
  • How much am I willing to risk per position? 
  • Should I engage with a finance professional?

As soon as you have come up with a broad strategy that you feel comfortable with, the most difficult question will be which ‘growth’ companies to buy. Whilst the basic principles of research are similar compared to blue-chip companies, analysing small cap stocks can be a little tricky, especially if those companies are not making a profit yet. Valuations as well as earnings forecasts are often based on assumptions, company specific catalysts and personal views. However there are certain guidelines that can help you find great growth companies with favourable future outlooks.

Here are some tips:

  • Management: How strong is the track record of the management team?
  • Financials: Is revenue rising? What’s the development over the past three financial years?
  • Catalysts: Which factors are likely to drive the share price?
  • Hurdles: What are the primary risks?
  • Industry: What is the general outlook for the industry?
  • Stock price: Is the stock price rising?
  • Investment view: Is the balance of risk even, favourable or negative?

Wise-owl is the Small-Cap Expert in Australia

Wise-owl was the first company in Australia to specifically cover small-cap companies on the ASX. Until today the ‘Growth Portfolio’ remains one of the most attractive features of our service and no other company in Australia has such an in-depth understanding of the risks and rewards associated with Small-cap investing.  Our head analysts Tim Morris has been featured on Bloomberg, Reuters, Sky Business or the Australian to share his expertise about the small and mid-cap industry of Australia.

Every research report in our ‘Growth Portfolio’ follows the same strategic model and we only recommend companies that satisfy all of our criteria. The outlook for these recommendations is generally long-term which has yielded above-average returns over the past 15 years. If you want further information about small and mid-cap stocks and you are a subscriber, log on to the portal or get in touch with your advisor. If you are a guest feel free to sign up for a free trial or call 1300 306 308 and talk to us today.

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Investor 101

Common Share Market Terminology for Beginners – Part 1

Common Share Market Terminology for Beginners Part 1

Share Market Terminology for Beginners – Part One

ASX Investment Education. Find below some of the most common share market terminologies explained for beginners. Click here to read part 2 of the Wise-owl Share Market Terminology series.

Bear Market:

A bear market is a period of pessimism and declining stock market prices, where selling outweighs buying. There is no specific criteria for a market to be classified as a bear market, however a decline of around 20% in value is often considered to be a common feature of a bear market. The reason behind the name is not entirely clear, however a frequently used explanation is the way a bear attacks its victim with a downward swipe.

Blue-Chip Stocks:

Blue-chip stocks are generally classified as well established companies with several years of strong financial performance and large market capitalisations relative to the market. Generally the company will pay consistent and reliable dividends and be a household name. Blue-chip stocks are often referred to as ‘safe investments’, however it must be noted that investing in blue-chip stocks does not guarantee returns.

Bull Market:

A Bull Market is a period of optimism where an entire financial market or an individual financial instrument trends upwards and there are more buyers than sellers. There is no specific criteria for a market to be classified as a bull market, however if a financial market or instrument increases about 20% in value, the cycle is generally considered to be a bull market. The reason behind the name is officially unclear, however one of the most frequently used explanations is the way a bull attacks its victim in an upward style.

Dividends:

A dividend is a distribution of a portion of a company’s earnings to its shareholders. The amount to be paid is decided by the company’s board of directors. Investors can choose to reinvest the dividend or simply take the cash. Dividends may be quoted in dollar terms or as a percentage of the market price, which is referred to as the dividend yield. Generally a consistent or growing dividend yield is a sign of a strong company, however there are some exceptions. To qualify for a company’s dividend distribution, an investor must purchase the stock before the Ex-Dividend date and be on the registry of the company on or before the Record Date. Usually the Ex-Dividend date and the record date are 2 days apart, as it takes 2 days for the purchase to be processed and the investor to be registered as the owner. There is no obligation for a company to pay dividends, however many companies use it as a tool to reward existing and attract new shareholders.

Earnings per Share:

The earnings per share (EPS) is a portion of a company’s net income to each outstanding share of common stock. The calculation for earnings per share is “Net Income – Dividends on Preferred Stock / Weighted Average Shares Outstanding”. In simpler terms, it’s the company’s net income divided by the number of shares outstanding. EPS is an important variable in determining the performance of a company. Investors often look for a company with growing EPS. EPS is often used to assess the current valuation of a stock by dividing the company’s current stock price per share by its EPS. The so called Price-to-Earnings multiple of P/E can then be compared to the market or sector average or with other competitors.

Exchange Traded Funds (ETF):

An ETF is a financial security that tracks the performance of an index (or any other basket of assets) and is traded like a common stock on a stock exchange. The price of an ETF fluctuates with the price of its underlying asset. An investment in ETFs provides exposure to diverse markets without the need to invest in each stock separately.

Ex-Div Date:

Ex-div date generally occurs two days before the Record date and is the date that determines if an investor is eligible to receive a dividend. The investor has to buy the stock at least one day before the ex-dividend date in order to receive the distribution. The date is usually determined by the local stock exchange.

Fundamental Analysis:

Fundamental analysis is a form of stock analysis which assesses the value of a company based on various elements and factors. It uses quantitative and qualitative methods to form an assessment and analyse the relationship between a company’s share price and influential elements. In order to perform quantitative or qualitative analysis, an investor must look at a company’s revenue generating capabilities, balance sheet, cash flow, operational activities, management track record, industry analysis, brand value or competition.

Hedging:

Hedging is a common strategy used in stock portfolios and derivatives which enables investors to manage risk. Hedging is often compared to an insurance policy as it is used to offset the risk of potential losses of one’s investment. In order to hedge, an investor will invest in a stock or an asset with lower volatility in order reduce the risk of the overall portfolio.

IPO:

An Initial Public Offering (IPO), also known as a ‘float’ or ‘going public’, is the initial sale of a private company’s stock to the public before it lists on the stock exchange. For more information on IPO’s refer to our article What is an IPO or Initial Public Offering?

Limit Order:

A limit-order is a buy or sell order placed with a broker to buy or sell a certain amount of shares at a certain price or better. Because the order is not at market price, there is a chance the order will not be executed or will only be partially executed. The order also has a time period attached, stating how long the order can be outstanding before it is canceled. For example, an investor places a limit order to purchase 200 shares at a price of $1.20 with an expiration date 2 days from now. Currently, the stock is trading at $1.22. If the broker is not able to purchase the stock for $1.20 within 2 days, the order will simply expire. However, if the stock does reach $1.20 the order will automatically be executed.

Liquidity:

Liquidity is the availability of liquid assets of a stock, security or market. It is the ease with which an asset can be bought or sold without affecting its current price. It is connected to the volumes of a stock traded, as higher volume facilitates greater liquidity.