Getting started in the stock market

Getting started in the stock market is very easy and simple.

Unlike property where a large deposit and stamp duty is a prerequisite, investors in the share market don’t require a large amount of capital to get involved.

Investors in the stock market can start with a small amount of capital to get a feel for the process and increase their confidence, then gradually build up their investment over time.

Another enticing aspect of the stock market is the liquidity it offers investors.

Whereas selling a property generally takes months as you search for an appropriate buyer, reach a settlement and then receive payment.

On the other hand, stock market investors generally can find a willing counterparty (buyer or seller) immediately, and will receive the proceeds of the transaction in their bank account within three business days.

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When it comes to investing in the stock market it can be intimidating, people are often confused by the stock tickers and flashing lights.

However when stripped back to its most basic concept the aim of investing in the stock market is simply to invest in high quality businesses.

When you put your money into ‘stocks’, you are purchasing a complete part of a business, entitling you to a portion of that businesses future earnings stream and profits.

For example, investors in the stock market have the option of becoming a shareholder in the Commonwealth Bank of Australia (CBA).

At present many people would be a customer of CBA with a savings account earning a paltry 2.50% – 3% on their cash.

However as a shareholder, or part owner of the CBA, you are entitled to a fully franked 5.90% (approx. 7.50% grossed up dividend), as well as any capital growth in the share price (5 year return: 43.60%).

Naturally there is a risk involved, nevertheless the trade-off between risk and reward can be significantly more favourable for the shareholder than for the cash deposit holder, and that’s the attraction many wealthy and successful individuals have with the stock market.

Once someone makes the decision to invest in the stock market it’s vital to build a diversified portfolio of different businesses to ensure risk minimization.

Unlike operating a family business where the owners effectively have “all their eggs in one basket”, investors in the share market have the luxury of owning a number of different quality businesses with the concept being that if one or two businesses don’t do so well, there are a number of other businesses in the portfolio that can more than take up the slack.

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There are over 2000 companies on the ASX split across 10 official industry sectors.

Of the companies listed on the market, although there are a large number of household names typically found within the ASX 300 index, there are also a number of small start-up companies that typically have significantly higher risk attached.

An investor in the share market needs to determine their risk profile before constructing their portfolio and should consider seeking advice to ensure desirable outcomes are reached.

First time investors often make the mistake of favouring certain companies because they are considered ‘blue-chips’ investments.

The term ‘blue-chip’ however tends to be very ambiguous.

Are ‘blue-chips’ well known household names, or are they fundamentally sound businesses with growing earnings profiles?

BHP is often cited as an example of a blue chip company, however in recent times the share price performance has been anything but stable and safe.

Another distinctive misconception made by those investing in the market for the firsttimeisto shy away from stocks with high dollar prices.

The primary reason for this is simple psychology.

I think it’s important to outline that the absolute value of a company’s share price has no bearing on a company’s performance going forward.

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The per-share price of a stock is often thought to convey some sense of value relative to other stocks, but nothing could be further from the truth.

When it comes to selecting the make-up of a portfolio there are a number of different portfolio construction methods.

The method favoured by us at KOSEC is a method that has delivered consistent results for our clients over the years.

The method is often broadly referred to as a ‘Top-Down’ investment approach which implores investors to take particular note of the global and domestic economic landscape before delving into the fundamentals of specific businesses.

Let’s for a moment consider a tale of two sectors of the economy.

On one hand we have the predicament of the mining and energy sectors, while on the other we have the undeniable momentum behind the healthcare sector.

Economics will tell you that a situation where supply is increasing and demand remains constant or declines, what transpires is a fall in prices.

Subsequently after years of increasing production capacity in the mining sector a flood of supply has coincided with concerns over global growth.

Falling like dominos over the past 18 months we have seen the price of coal, iron ore, oil, and gas all decline markedly, placing significant downward pressure on the companies within mining and energy sectors.

With the population demographic aging and developing world middle classes emerging, demand and reliance on the healthcare sector will continue to grow in the coming years.

It is estimated that the number of people over the age of 70 will double in Australia over the 2006-2021 period, fundamentally changing the shape of the Australian economy.

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Naturally it’s a lot easier to predict how many of the population will be getting older over the next five years, than it is to predict what the price of iron ore will be in five years.

If I were to ask you to decide which sector you’d prefer to invest in, what would your response be? The sector with adverse momentum or the one with positive sentiment?

It’s exactly these sorts of broad economic themes that investors should latch onto to help guide with investment decisions, rather than blindly following a business because they’re big or well known.

In many ways we believe in keeping things simple by following the simple process of first identifying sectors of the economy that are booming, before then going a step further and selecting established businesses within those sectors that are financially sound and have a track record of performing strongly.

We believe that everything that has and will happen, is a part of a long documented chain of cause and effect.

So why buy into fanciful turnaround stories, why complicate things?

There is no need to invite excess unknown risks when you can keep it simple and get the desired results.

Michael Kodari is the founder of KOSEC – Kodari Securities, and one of Australia’s prominent experts in the stock market. With a strong background in funds management and stockbroking, Michael has worked with some of Australia’s most successful value investors and consulted to leading financial institutions. Michael writes for Australia’s key financial publications and is one of the nation’s most consistent, top performing investors. He has been referred to as ‘the brightest 21st century entrepreneur in wealth management' and ‘a trailblazer within the Australian stock market’, CNBC Asia.