How To Buy Shares In Australia

My sister asked me a good question the other day. She asked "How do I buy shares?"

Of course I launched into a long and detailed explanation involving dividend yields, return on equity and interest coverage ratios, at which point she interrupted and told me she just wanted to know how buying shares works - how you physically purchase them.

Buying stocks for the first time can be a daunting experience. There is a lot of new terminology which seems especially designed to confuse new investors. So this article is aimed and beginners who what to learn how to buy shares.

Why Do You Want To Buy Shares?

First a quick recap. Before taking the plunge it's worth thinking a little about your reasons for investing. While stock market investments have performed well over the longer term they can be a little volatile over the short term. You only need to look back at the behaviour of world equity markets in late 2008 and early 2009 to see evidence of this.

For this reason, most people consider shares to be a medium to long term investment (sure, there are stock traders who only hold positions for days or even hours before selling but that's another story). Three to five years or longer is typically quoted as a reasonable holding period. So if you're looking for somewhere to stash the money you're saving toward that holiday, the stock market is probably not the place.

What Do You Get When You Buy Shares?

It's important to understand that when you invest in equities, it's more than just a ticker symbol you see quoted in the financial newspapers or on the news at night. You're buying a part ownership in a company - a real business. I think that's a critical point to remember. It's not like money in the bank or a term deposit - you own a small part of a business.

As such you're hoping that the business will grow and that your stake in the business will grow along with it so that you will one day sell your stake for more than you paid for it. You would probably also expect some income in the form of dividends along the way.

So, How Do You Buy Shares?

In practical terms, there are really two ways to invest in shares. You can buy them when a company floats on the Australian Stock Exchange or you can purchase stock in a publicly listed company 'on market'. (There are actually special circumstances where you can purchase shares off-market but these scenarios are beyond the scope of this article.)

Buying Shares In A Float.

When a company lists on the Australian Stock exchange it's called a float. What typically happens is that shares in the company are offered to the public in what's called an Initial Public Offering or IPO.

The company must produce a document called a prospectus which contains information about the history and nature of the business, financial results, any risks inherent in the business and what the future plans for the company are (including what they plan to do with the money raised by the offer). It's a very important document and should be read very carefully by any prospective investor.

It's worth noting that Telstra and Commonwealth Bank shares are the exception when it comes to stock market floats. Typically new companies listing on the ASX are much smaller with shorter operating histories than these two blue chip behemoths. And a fair proportion are outright speculative punts - junior oil and minerals explorers looking for a big resource discovery.

However, if you know what you're looking for, you can occasionally find solid businesses with a good record of profitability listing at reasonable valuations. It can be a good opportunity to get in early on a fast growing company. CSL and Cochlear are two companies which come to mind. Investors in the original float of either of these companies would be sitting on very tidy profits right now.

Although it probably shouldn't be a big consideration, you should also know that there is no brokerage payable when you invest through an IPO.

Buying Shares Through A Stockbroker

Types Of Broker

Full service brokers provide advice to their clients. They will provide recommendations on how to invest your money including what specific stocks to buy and sell. You will normally pay more for this level of service.

Discount brokers will allow you to buy and sell stocks but don't provide personal investment advice. They sometimes offer research information which is general in nature. Their brokerage fees are generally lower.

And speaking brokerage, that takes us nicely into the other main way of buying shares - on the sharemarket through a stock broker. When you buy shares in publicly listed companies through the stock exchange you're buying from another party. You're not buying from the stockbroking firm or from the company itself. There needs to be someone selling in order to buy. The seller may be a private investor like you or they may be an institution like a fund manager. The thing to remember is that you're buying a piece of a business from another party.

Shares listed on the Australian Stock Exchange need to be bought through a stockbroking firm. The stockbroker is responsible for executing purchase and sale transactions on you behalf. For this service they charge a fee called brokerage.

In order to operate as a share broker in Australia, you must be licensed by ASIC (the Australian Securities and Investments Commission). To be safe you should check that your broker is licensed by ASIC.

Before a stockbroker will accept your order, you'll normally have to set up a trading account with them. This is usually a fairly straight forward affair and shouldn't take more than a few days to to complete the process.

Most brokers will also need your bank account details. This is so that funds can be transfered to and from your account to pay for any purchases or receive the proceeds from any sales.

Order Types - 'At Market' and 'At Limit'

When it comes time to make your purchase, there are 2 types of order you can place - 'at market' and 'at limit' orders.

At market orders mean that you are seeking to purchase a set number of shares in a company at whatever the prevailing market price is at that time. So in effect, you will be accepting the offer of a seller who is selling at the lowest price.

At limit orders differ in that instead of just buying at the prevailing market price, you set the price at which you're willing to buy (or sell). This may be above or below the current market price. If you place an at limit order below the current market price, you will need to wait until the share price drops to that level before your order is executed. If the price doesn't get that low then your order wont be executed. I think under ordinary circumstances your order will be valid for 30 days before being purged from the Australian Stock Exchange system. There are a number of exceptions to this rule - I think one of them is when a stock goes ex-dividend.

Most brokers allow you to place orders to buy shares online or over the phone (check out the brokerage fees as they sometimes differ depending on the method you use to place your order). Whichever method you choose, make sure you check, then double check the details of your proposed transaction (make sure you don't have too many zeros), as once the trade takes place you are committed.

Settlement

Once your trade is executed, there is what's called a settlement period of 3 (business) days. After 3 days the broker 'settles' the trade - they will take the funds from your bank account to pay for the transaction and you will then be the legal owner of those shares.

Unlike in the old days, you wont actually receive a paper share certificate. What you will receive is a CHESS Holding Statement. This statement lists your current shareholding along with any recent transactions. The CHESS system is responsible for handling the settlement of stock market transactions and for maintaining who is the registered owner of each parcel of shares.

There are 2 options for managing your shareholdings. You can choose to be Broker Sponsored or Issuer Sponsored. If you're Broker Sponsored it means that your stockbroker is able to manage your holdings on your behalf. With Issuer Sponsored, the company you hold shares in will manage the holding. Visit the ASX website to find out more about the differences.

I find being broker sponsor to be more convenient as all of my holdings are grouped together and if I ever need to change any details (like my address) it all gets done in one go.

What's Next?

You've probably noted a glaring omission from the article - choosing the best shares to buy. Well that topic is a whole series of articles in itself. I have offered some of my thoughts on this topic in the past and I'll share some more in an upcoming post.

Kathmandu IPO - Kathmandu Shares Set To Float

Hot on the heels of the initial public offering of Myer shares comes the Kathmandu float. It seems that the present owners of the outdoor goods and clothing retailer have judged that now might be a good time to sell down their stake given the recent strength in Australian shares and the high levels of demand being reported for Myer shares.

The Kathmandu prospectus is available from the kathmanduholdings.com website. The retail offer is set to open next Tuesday and close at COB on 6 November. The share offer is expected to raise between $278M and $375M through the sale of between 167 and 197 million shares at a price of $1.65 to $1.90. The proceeds of the offer will be used to pay down debt, fund the cost of the offer with the balance going to the present owners of the company.

Kathmandu was bought from founder Jan Cameron by Goldman Sachs JBWere and Quadrant Private Equity in 2006 and they are now looking at taking some money off the table. It has been reported that they may retain a stake of up to 15% in the listed entity but I suspect that will depend upon demand.

In order to buy shares in the offer you need to purchase through a broker who has received an allocation. There is some stock available to employees with the rest being sold in an institutional offer.

Kathmandu shares will be listed on both the Australian and New Zealand stock exchanges. The retailer operates 84 stores in Australia, New Zealand and the UK and is looking to open another 18 stores.

Myer Prospectus Released

Here is the latest update on the initial public offering of Myer shares.

Today the prospectus was made available for download on the Myer website. I have downloaded it and had a quick scan through.

One thing that struck me is that there is no application form. As far as I can tell, retail investors have 3 options to invest in the float:

• as a staff member of Myer;
• as a member of the loyalty card program; or
• through an allocation from a stock broker.

If you don't fall into one of these categories, the prospectus says that you will be eligible if you're a member of Myer One loyalty card program on 23 October 2009. I guess that means you still have time to become a member.

The offer will be priced between $3.90 and $4.90 per share with the final price to be set upon completion of the institutional offer.

It seems that demand will probably be strong as I read in The Age today that 140,000 investors have pre-registered their interest in the share offer.

Myer Float - How To Buy Shares In The Myer IPO

Since my post yesterday on the IPO of Myer shares, I've had a couple of questions about how investors can get access to the float. As I mentioned yesterday, the strong brand name will probably attract lots of retail investors to the float and I guess people are worried about missing out.

According to the offer website, as long as you become a Myer One member by 5:00 pm on Friday 25 September, you will be eligible to preregister and have your prospectus mailed to you along with a personalized application form.

But I also read in the FAQ that you will not receive any priority by preregistering.

"If you apply for shares under the Myer Share Offer, you will be treated the same whether or not you have pre-registered."

So there appears to be no reason to panic just yet. Although there has been speculation that preferential treatment would be given to loyalty card holders, the information in the FAQ does seem to contradict this.

If you're worried about missing out, maybe the safest bet is to join up to the loyalty card program before Friday. That way you'll be covered if investors who preregister their interest in the IPO do receive preferential treatment in the Myer float.

Myer Shares Set To Float

It looks like Myer shares will once again be available on the Australian stock market. The Myer IPO (Initial Public Offering) could well be wrapped up by the end of the year.

According to the www.mypieceofmyer.com.au website, the group "currently intends to lodge a prospectus with the Australian Securities and Investments Commission for the offering of shares in Myer Holdings Limited on or about 28 September 2009".

With the ASX indices racing ahead over the past few months, it may well be an opportune time for the float, providing the Aussie sharemarket doesn't fall over in the next month or two. We've managed to get through the 1st anniversary of the GFC, but October has been a diabolical month for investors in years gone by - although not so much in recent years.

Pre-registration for the Myer float is only available to the company's staff and for Myer One loyalty card members.

The TPG (Texas Pacific Group) led private equity consortium took the iconic retailer private just over 3 years ago. Since then they have managed to increase profits and (not surprisingly) management say that recent trading has been strong.

The interesting thing for me will be the structure of the new listed entity's balance sheet - or more specifically, how much debt it carries. The modus operandi in most private equity deals is the use a lot of leverage (debt) in the buyout. Sometimes when the shares are floated they still carry a significant level of debt. Repco is one of those situations which comes to mind. The cyclic nature of retailing along with excessive debt can be a risky combination.

I suspect that the issue will still be popular though. It is a well known brand which along with some heavy marketing aimed at retail investors should ensure the Myer share float is successful.

Exchange Traded Funds - ETF Investing In Australia

My interest in Exchange Traded Funds has grown since I first wrote about asset allocation a few months ago. As you may recall from that post, I like the strategy as a way of diversifying away from Australian shares and as a way of making the investment process more objective and systematic. Anyway, this line of reasoning caused me to search for a cost effective and relatively simple way of implementing a fairly basic asset allocation - and the humble ETF fits the bill.

What Are Exchange Traded Funds?

An ETF is an open ended fund which trades on the stock exchange (open-ended means that the fund can issue or redeem shares at any time). Most of the ETFs I've looked at are designed to track the price of a particular index. They are similar to shares in that you can buy and sell them through your normal stock broker. The only cost you need to pay is brokerage. Another way in which they are like shares is that they pay distributions in a similar way to which shares pay dividends.

The funds' underlying investment is in the shares that make up a particular index. So an ETF designed to track the performance of the ASX 50 will aim to hold each of the components of the ASX 50. This is why the price of an ETF will track the price of the index. There are some mechanisms in place to ensure this is the case and that the share price does not vary too much from the underlying index. Basically there are market makers (also known as authorized participants) who buy or sell depending on demand in order to ensure an orderly market.

Why Use An ETF?

If you're looking for a way to gain exposure to shares in a particular region or market segment but don't want to have worry about choosing shares to buy yourself, then I think Exchange Traded Funds have a number of benefits.

As I mentioned earlier, you can buy or sell shares in an ETF on the Australian Stock Exchange just like you would any other shares. This makes them quite a convenient investment vehicle. For the cost of brokerage, you can buy a stake in the S&P 500 (one of the popular US large cap stock indexes) or maybe the S&P Europe 350 (an index comprised of 350 European stocks).

As well as being cheap to buy compared to managed funds or buying international shares directly, they also have low management fees compared to managed funds. This is because they take a passive approach to their investments by just buying the index resulting in lower transaction costs and there is no need to employ highly paid active investment managers.

Exchange Traded Funds may also offer some tax advantages over more actively managed funds. Because they mostly buy and hold (except for portfolio re-balancing) there is less capital gains tax payable because the underlying share are not frequently bought and sold.

Where I find ETFs to be most useful is in gaining exposure to international shares. I manage my own portfolio of Australian shares but I don't have the time or the expertise to invest internationally. ETFs give me that diversification at a low cost and with the convenience of being able to buy and sell directly on the Australian Stock Exchange.

ETF Providers

Most of the international exchange traded funds which are listed on the ASX are issued by Barclays Global Investors, although they trade and are marketed under the name iShares. There are also a couple of Vanguard funds. Vanguard have built quite a reputation as an index fund manager. They also offer some unlisted funds, although I believe the management costs are higher.

The Australian ETFs are issued by State Street Global Advisers and Vanguard. The State Street products trade under the name Streettracks.

Exchange Traded Fund List

There are many to choose from. Here is a list of some of them.

Australia:

- SPDR S&P/ASX 50 Fund (ASX:SFY) - tracks the performance of Australia's largest 50 companies.
- SPDR S&P/ASX 200 Fund (ASX:STW) - tracks the performance of Australia's largest 200 companies.
- Vanguard Australian Shares Index - tracks the performance of Australia's largest 300 companies.
- SPDR S&P/ASX 200 Listed Property Fund - tracks the performance of the S&P/ASX 200 A-REIT Index

International ETFs:

There are many products available to give investors access to a broad range of international shares. As you would expect, American shares are well represented. iShares offer US Large-Cap, Mid-Cap and Small-Cap products tracking various S&P indices and the Russell 2000 index as well. Vanguard also offer a fund which tracks the overall performance of the US market.

In Asia, iShares offers products tracking the MSCI index for Hong Kong, Singapore, Taiwan, Japan, or South Korea or the FTSE/Xinhua 25 index in China.

There is a iShares product for Europe which tracks the S&P Europe 350.

Then there's a number of products with broader scope. There's an iShares Emerging Markets Exchange Traded Fund which I guess you could say is more theme-based, rather than region based. Or the BRIC index (representing Brazil, Russia, India and China) is available as well if you're a believer in the economic growth story of these parts of the world.

Or you can zoom out even further and invest in the S&P Global 100 index, made up of 100 large-cap companies from around the world.

Exchange Traded Commodities

For investors who want to invest in commodities, ETCs (Exchange Traded Commodities) could be an option. These products are similar to ETF's except instead of buying shares, I believe the funds actually buy and hold the actual commodity. As I wrote about in my post about investing in gold, there is a gold ETC available. Or you can choose from platinum, silver and palladium. I need to research these a little better. Once I do, I'll write more about them.

Currency Risk

Just to wrap things up, I should point out that to the best of my knowledge, none of the International ETF's employ any sort of currency hedging strategy. This means that for the duration of your investment in the fund, you are exposed to currency fluctuations of the Australian dollar against other currencies.

So for example, if you bought into one of the US funds, and the $A increased in value against the $US, then the value of your investment in Australian dollar terms will have fallen even before taking into account the performance of the underlying investment.

This is not the end of the world. But it is something to be aware of when buying international Exchange Traded Funds.

Best Shares To Buy Now For The Long Term

Many investors will be feeling bruised and battered after a year or two of punishing stock market conditions. Even those who don't purchase shares directly will be feeling the pain. Superannuation returns have plummeted and most managed funds have gone backwards as well. So how do we as investors go about finding the best shares to buy now that stock prices seem to have stabilized?

In this post I'd like to describe some of the criteria I look at when investing. With share prices cheaper than they've been in years (although not as cheap as they were in March) I think now is a good time to buy shares provided they are as a long term investment in a quality business.

Perhaps at this point I should provide a caveat. I think there is a good chance that the Australian stock market will fall again in the short term. It has probably risen too far, too fast and any unexpected nasty surprises could trigger a sell-off. Or it might just be a round of profit taking as traders seek to lock in their short term gains. But if you're buying with a 5 year plus time-frame in mind, then short term setbacks shouldn't be too much of a concern and today's share prices will look good value.

Finding Good Shares To Buy Is About Reducing Risk

If events over the past 18 months have taught us anything about investing, it is that we need to understand the risk we take when we invest. Not just when buying stocks. It applies equally to other financial products as well. If you look back over the past year or two, you'll notice the financial landscape is littered with collapsed investment schemes. Opes Prime and Storm Financial are two high profile Australian examples but there are plenty more.

Permanent loss of capital is something which I believe should be avoided at all costs. Consider a portfolio of 10 stocks, each with with equal weighting. If you were to sustain a 100% (permanent) loss in one of those holdings (think of ABC Learning or Babcock & Brown) then you would need to generate a return of over 11% on the rest of the portfolio just to break even! Avoiding such disasters puts you ahead of thousands of other investors already (even some of the professionals).

For this reason, debt is one of the most important things for me to look at. I'm interested in the debt to equity ratio, the interest coverage and any debt that falls due in the short term.

Debt to equity is the amount of debt a business takes on when compared to the shareholders' equity. It's difficult to prescribe an exact ratio to look for as companies in different industries can sustain different levels. Cyclical industries like retailing have cash flows which can vary greatly through the economic cycle so high levels of debt are a problem during a downturn. Conversely, utilities with relatively stable cash flow through the economic cycle can probably sustain higher levels of borrowing. But in general, lower is better. Less than 1 is good and less than 0.5 is better.

Interest coverage is another thing to check. A company's ability to service it's debt is critical. The interest coverage ratio is the number of times the interest bill is covered by EBIT (Earnings Before Interest and Tax). I like 3 times as a rule of thumb but obviously more is better. Also, I like to go back over the past 5 to 10 years and pick what looks like the lowest EBIT figure over that period and use that in my calculation. That way I know that there's adequate coverage even at the bottom of the economic cycle.

What Are The Best Performing Shares?

Making sure that a company will still exist in 10 years time is one thing, but I also want to know that I will earn a decent return on my hard-earned cash over that tome. For that reason, I want to know that a company is going to take my investment and do something with it.

There are a couple of measures I look at to find out. Return on equity is one. It provides a measure of the rate of return the company is able to generate on its shareholders' funds. So a company which can generate a return of 15% on equity over an extended period of time is a pretty good investment. If this return is maintained as the equity levels grow (ie. the company is reinvesting profits into the business and continuing to generate good return on this additional investment). For companies with high levels of debt, the return on equity figure can be inflated by the level of leverage used. However, as I've already noted, I'm trying to avoid those companies with significant levels of debt.

Alternatively, we could use return on invested capital as our performance measure. Some argue that it gives a more realistic measure of financial performance as it takes into account all of the funds employed in generating profits, not just those contributed by investors. After all, a company which only takes 100 million dollars to return a profit of 20 million dollars probably has a better business than one which has to invest 200 million dollars to earn that same 20 million dollars even if in each case shareholders have only contributed 100 million dollars (the additional $100 million for the second company was funded by debt).

Value is important as well. Low debt and a high return on invested capital don't justify an excessive share price. I want to invest in a high quality company but if I pay too much then the return I can expect on my investment over the long term will be correspondingly lower.

What I like to do is build up a list of stocks which meet these strict quality criteria, then rank the list according to their relative value, from cheapest at the top to most expensive at the bottom. I can then apply some more subjective criteria to a handful of the stocks at the top of the list. Online brokers like ComSec have all of the data I need to compile my list. If your online broker doesn't have the information, you could use NineMSN or even the Australian Financial Review website (but I think you have to be a subscriber).

What I mean by subjective is to look at some of the factors which can't be boiled down into simple ratios and percentages. I need to use my judgment as to the future of the industry in which the business operates. I need to make an assessment of the quality of the management running that business. After this process, one or two companies will stand out and these are typically the ones where my money gets invested.

By following the above process, I hope to find not only the best shares to buy now, but also those that are worth holding in my portfolio for the long term.