Transcript STEP TWO:

By now you have narrowed
your down your choice of
shares and have included
them into your own watch list.
Now you need to do some
share market analysis and
this is where the homework
comes in! Share analysis
consists of the two schools of
thought – fundamental and
technical analysis.
Fundamental analysis addresses the question of "what shares to
buy". It is concerned primarily with analyzing the future
profitability of the company.
STEP 2 will focus on the
Fundamental Analysis part
of Share Market Analysis.
Essentially this section will
answer the “What” to
buy/sell question?
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When we talk about Macro Fundamentals, we mean how does the company operate within the
economy?
If the economy is doing well, then the industry should be doing well. If the industry is doing well,
then the individual sectors should also be doing well and hence the companies and the share price.
In other words, you want to see growth in the economy.
There are many factors that would affect the economy but the three most important factors are:
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Inflation - This is public enemy number one! Watch the level and trend of the inflation rate and
be aware of what may influence inflation. For example, a rising oil price would mean higher
transport costs, which will have a knock on affect for everything else.
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Interest rates - The Reserve Bank uses this as a tool to handle inflation. It is also the price of
money. Watch the level and trend of interest rates and be aware of what would influence a
higher interest rate environment. For example, inflation or a weak currency·
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Exchange Rates - The Rand's weakness or strength against its major trading partners does
influence companies that are either importing or exporting goods, and hence their shares on
the market. Again watch the level and the trend, as well as have an opinion on what influence
a stronger or weaker Rand.
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Once you have formulated an opinion on the general economy (i.e. inflation and
interest rates), you have a better idea of what may affect the general economy.
Now you need to zoom-in on the individual companies in your own watch list.
Ideally you would either get hold of their annual financial statements, which
includes the Balance Sheet, the Income Statement, as well as the Cashflow
Statement.
Now its about understanding Ratio Analysis - The most important financial ratios to
analyze is not EPS growth, but rather the following:
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P/E Ratio - This is the Price to Earnings ratio i.e. the price of the share divided by the historical
earnings per share.
P/NAV - This is the Price to Net Asset Value ratio i.e. the share price divided by the NAV.
DY% - This is the Dividend Yield i.e. the dividend per share (DPS) expressed as a percentage of the
share price.
ROE % - this is the Return on Equity, which is the headline profits attributable to ordinary shareholders
divided by the weighted average ordinary shareholders' funds. Compare this return with the return of
you receive at the bank (which also offers lower risk). If the return from this company is higher than at
the bank, then we have a better quality investment.
Interest Cover - this is one of the most important ratios to consider financial risk. Interest cover
should at least be above three times cover, which is the minimum cover required. This means that
there are sufficient profits to pay the current interest charge three times. Below this level, we would
rarely contemplate an investment.
Cash/EPS - this is the cashflow per share (i.e. the cash provided by operating activities less
depreciation divided by the weighted number of shares) divided by the headline earnings per share
(HEPS). Any ratio above 0.75 can be considered very good, while any ration consistently below 0.50
should be questioned.
At this stage, you just want to have a "preliminary fundamental checklist", which will help you
decide whether the share in your own watch list merits further analysis.
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Nature of the business: (What does the company do? What are their products,
services, divisions, etc?)
Sector: (What JSE Sector does it fall into? Who are the competition?)
Sector PE: (What is the sector PE ratio? How does that compare to the PE of the
market?)
Price: (What is the current share price? What is the last 12-month high and low?)
Share PE: (What is the share PE ratio? How does that compare to the PE of the
sector? Ideally a low PE ratio)
Turnover Growth %: (What is growth % compared to the previous year? Is it
outperforming inflation?)
Tax rate %: (What is the effective rate % (25-35%)?)
ROE %: (What is the Return on Equity (ROE) > 20%?)
NAV: (What is the Net Asset Value (NAV) of the share? Is it trading at a discount?)
Price/NAV: (What is the share price compared to the NAV? Ideally < 2)
Interest Cover: (What is the interest cover i.e. >3-times?)
Step #2 should have provided you with a list of Fundamental
Analysis checks which by completing this ‘checklist’ will ensure that
you are able to identify and separate good undervalued shares from
overvalued and underperforming shares!
Activity: Apply the Fundamental Analysis Checks to the shares in your initial watchlist.