posted 08-04-2003 01:05 AM         

Strategies for Maximising Profit from your investment.

Understand the nature of the share market
Recent company floats, led many first-time investors to believe that the share market is an easy way to wealth creation, a virtual cash cow. This is not the case, though profits are certainly there to be made.

Although many first-time investors have seen the value of their investments increase dramatically, it is important for them to understand the true nature of the stock market. The market is a volatile and unstable creature. It has had periods of frantic booms, during which many investors have the opportunity to accumulate great wealth. But these booms have usually been followed by severe downturns, during which time many investors have lost out. Particularly hard hit are those who are highly geared, that is those who have borrowed large amounts of money to purchase their shares.

One successful approach to investing in shares is to be a counter cyclical investor. This means attempting to buy shares during periods when the share market is weak and selling the shares once the market has risen. The main problem with this approach to investing is that it takes courage to buy shares when the mood of the market is glum and when all the papers are talking doom and gloom. It is also brave to sell your shares when everyone else is buying, but it is worth trying, as the results can be fantastic.

Understand the investment clock
Have you noticed how the beginning investor will often wait until the market moves before buying shares or property? The reality is that by the time the beginning investor is aware that the market has moved, the experienced investors have already moved the market to the next level. So, how do they do this? Well, the experienced investors tend to buy before the market starts to inflate and prices start to go up. They do this by understanding the investment clock, which is based on the well-known phenomenon that business cycles occur, on average, every seven to nine years.

Many investors have trouble coming to grips with the probability that events can turn out in a cyclical fashion. However, history indicates that the probability is very high indeed. The sooner you, as an investor, live through an investment cycle, and see the recurring nature of booms and busts, the sooner you will become a better investor and understand the importance of timing of your investment decisions.

Understanding the investment clock is a useful tool for guiding you along the journey to financial independence. It helps you know when to invest and the best performing assets at a given point in time.

The investment clock is not a really good tool for predicting the timing of economic trends with great accuracy. Its real value lies in its ability to depict the cyclical relationship between the share, property and fixed interest markets and the order in which they occur.

The clock tells you the most appropriate investment medium, considering the prevailing economic indicators such as interest rates, commodity prices and inflation. It shows that the share cycle is followed by the real estate and then the fixed interest cycles. The investment clock has proved accurate in reflecting the market forces that drive the various investment cycles. And the order in which they occur.

Look for value shares
Some shares represent better value than others do and investing in individual shares when their shares fall below what are likely to be sustainable valuations. For newcomers to the market, it may seem hard to identify these shares. However, taking a little time to understand how companies are valued can pay off. Studying the price to earnings ratio will enable you to judge which shares represent value and which ones are overpriced. The price to earnings ratio indicates the number of times the price covers the earnings of the share. This ratio is listed in the daily newspapers along side the share's price.

A company with a low price to earnings ratio can be considered a better value stock than a company with a high price to earnings ratio. Over time, companies with low price to earnings ratios have consistently outperformed those with high price to earnings ratios.

One thing to remember is that the price to earnings ratio is calculated on a company’s current financial situation. One company may have a higher price to earnings ratio than another but this could be due to an unusual recent situation. Similarly, the other company may have had an unexpected windfall that is unlikely to occur again.

So, before making a decision based solely on price to earnings ratios, it would be advisable to check the price to earnings ratios histories of the relevant companies.

Understand the psychology of the market
If the economic clock is well understood and the benefits of being a countercyclical investor are evident, why doesn't everyone make a killing? The simple reason is human nature. Two factors drive the share market: greed and fear. As the value of shares in the share market rises, most investors want a piece of the action and will buy more and more shares. This drives the prices up and leads to further buying. Such a market is known as a bull market. Everyone is happy, as long as the prices keep rising.

However, we know that such activity cannot continue indefinitely. The problem is that the emotion of greed is often stronger than rational thought. Conversely, when prices start falling, uncertainty sets in and most shareholders begin selling their shares before the price falls too far. As selling intensifies, share prices continue to fall. Before too long panic sets in as most investors try to divest themselves of their share holdings.

This is known as a bear market.

Although investors who keep their stocks should be able to sell them for a higher price once the next cycle comes around, the fear of loss forces many investors to sell their shares. Keeping a level head and understanding the market will give you a distinct advantage. Think how much profit you could make if you stood away from the crowd and were in a position to buy when everyone else is selling, and to sell when the pack wants to buy.

Aim at Buying emerging growth stocks
Buying stocks in emerging companies can be extremely profitable. These companies tend to fall in the category of mid cap (mid-sized) or smaller companies. The rewards from investing in these shares tend to be attractive as many of these companies are in the service and technology sectors of the economy, which at times grow at a higher rate than older manufacturing industries. These companies generally have more room to grow than larger established companies. Medium sized companies are also flexible and can more easily maintain their profitability.

The downside of investing in these companies is that mid cap companies that are still developing their potential are more of a risk than well established, larger and possibly more stable companies. Not all of these emerging companies will fulfill their growth projections. It may also be harder to exit the market when desired as shares in these companies may not be in great demand.

Try Minimising your risk
Most shares will rise as the market rises, and will fall as the market falls. There's little you can do to avoid this. However, if you don’t have time to watch the market you can take action to minimise the risk of losing too much of the value of your portfolio.

To do this, ensure that the shares that you purchase are representative of companies from a wide range of industries. So that your portfolio does not lose too much of its value when a particular sector is struggling, you should ensure you own shares representing companies from a wide range of industries, including technology, construction, finance, manufacturing, media, resources and retail.

If your shares are all in construction companies, your entire investment value falls when that sector suffers a downturn. However, if you have spread your risk, your investment will be cushioned if other sectors are experiencing growth. The old adage, don’t put all of your eggs in the one basket, is an apt one for the time poor investor.

Buy blue chip growth stocks to hold in the long term
One strategy that has proven its value over time is to be a long-term holder of major growth stocks as these types of companies have proven their ability to deliver superior performance over the medium to long term. Again, this requires regular scrutiny of the market. The most common term for these stocks is 'blue chip'.

Although blue chip companies have a history of regularly returning solid profits and dividends, don't be misled into believing they are immune to economic downturns. They're not. However, they are usually large enough to weather an economic battering better than smaller companies.

Whatever portfolio mix you are considering, you should include some blue chip stocks. The proportion you choose will depend on the type of mix you are after.

Keep an eye on your stock portfolio
Keep a constant eye on your stock. Apart from checking the value of your shares, read the newspapers to find out what is happening within your companies. Don't just look at the share price each week. Scan the business pages for news about major personnel changes, or news of strategic decision-making within your companies.

Share prices are very sensitive to factors within the company, as well as to outside economic factors such as interest rate rises and falls, balance of payment figures and the value of the dollar. External factors, such as the international economic situations or wars, can also affect share prices. Therefore, the more you keep informed about what is happening, the better your chances of making correct decisions.

Read the annual reports of all your companies. And, if you can, attend the annual general meetings. As a shareholder, you are entitled to attend, to present your point of view and to vote on crucial issues, such as the makeup of the board.

You'll also be given a great deal of information about the current and expected future state of the company, information that you can use to make informed decisions.

To be able to do all of this, don't buy stock in too many companies. For most people, keeping up with more than ten companies will prove difficult. If you are able to regularly track your stock, you will also get more enjoyment out of your portfolio.

Regularly review your stock portfolio
Conditions and situations change, so it is important that you regularly review your portfolio. Every few months, go back to your investment plan and see if your needs or conditions have changed. Consider whether some stock should be sold, or others bought. It may be a good idea to reduce your holdings in a sector that looks set to experience low growth for some time. Or increase your stock in a strong growing sector.

If the share price of one of your companies has been steadily falling and is below what you bought it for, consider whether you may be best cutting your losses and selling out of that company. You may be reluctant to make a loss on that stock but consider it in a different light. Selling now gives you the cash to invest in other stocks which may increase in value. Before long you may have recouped your losses and begun to make a profit. Holding onto non-performing stock is opportunity lost.

Also keep an eye on changes to your taxation arrangements. And to changes to taxation law. There's no point making handy profits if you've got to hand too much of it over to the government. The key to holding a successful share portfolio is in the portfolio's management. Keep a constant eye on it.

Consider Borrowing to buy
One strategy that some investors find valuable is that of borrowing to buy shares.
When interest rates are low, investors can expect a far better return from the share market than from banks.

The margin between the two investments is often wide enough for you to consider borrowing funds to buy shares. In effect, you're using someone else's money to invest, and using part of your profit to repay the interest.

For example, if you had $25,000 to invest in the share market and if your investment was successful you would get the benefit of the dividends and the capital growth in the share value of $25,000 worth of shares. Alternatively you could buy $100,000 worth of shares by using the same $25,000 as a deposit and using the shares you just bought as collateral or security to borrow the balance of $75,000.

Many banks and stockbrokers will lend you the funds to do this. Now you would be able to reap the rewards of the dividends from $100,000 worth of shares as well as the capital gains of a portfolio initially worth $100,000. And you would have still outlaid the same $25,000. This process of leveraging your investment is called gearing and in this case it could multiply your profits four fold.

Many investors have done well out of gearing their share portfolio, and when the market rises they have achieved results much higher than they could have without gearing. But the risk is also magnified. If the share market slumped and on average prices fell by 25%, an investor who started with a portfolio worth $25,000 would now have shares worth $19,500. On the other hand, an investor with a portfolio worth $100,000 has had the value of the shares cut back to $75,000.

This means that the value of the initial deposit has been lost and that the bank or broker would ask for their loan to be repaid, as there is no longer sufficient security. After selling the shares, the investor has enough money to pay off the lender but is left without any of the capital. Furthermore, brokers fees and stamp duty would have to be paid.

Negative gearing works best when you have invested in shares that have a high rate of growth over the medium term, and have a relatively low risk of large or prolonged slumps in prices. Also, if you are considering negative gearing, ensure that you have income available from other sources so that if the shares do not perform as expected, or if the dividend income is lower than expected, you are able to cover the difference between your investment income and the interest bill. You also need to have the funds to cover margin calls which occur when the bank or broker asks you to ‘top up’ your account to provide the security needed because the market value of your shares has fallen.

Because negative gearing allows losses on share investments to be offset against tax payable on other income, the main beneficiaries are high-income earners. Negative gearing is a high-risk investment and there is a risk of losing all your capital - and more! Yet for the right investor, who selects the appropriate stock, the possible benefits may well be worth the risk.