CHAPTER 4

Investments and Shareholders

Types of Shares

Shares are sometimes referred to as stocks, securities, or equity.

There are two main types of stocks: ordinary shares (also called common stock) and preference shares.

Ordinary Shares (Voting)

The global norm is for companies to issue ordinary shares, which are the main types of stocks traded in the market. These represent ownership in a company in the proportion of shares held. In addition to capital growth investors also receive a portion of profits in the form of a dividend. Some countries require that financials are declared every quarter, while some have two sets of financial releases a year.

As part owner of the company, shareholders have the right to vote (one vote per share) to elect the board of directors at the company’s Annual General Meeting (AGM). Should a company go bankrupt and liquidate, the common shareholder will receive money only after creditors, bondholders, and preference shareholders.

Preference Shares

Preference shares usually do not have voting rights, but are guaranteed a dividend before ordinary shareholders.

These take the form of:

Debentures

Depending on the country defining a debenture, the meaning can be completely different. In many countries in emerging markets, debentures are defined as fixed-interest securities, which are repayable to the investor at a given date and are linked to a specific assets, thus these have a high degree of security. The disadvantage of this security is a lower interest rate and does not provide ownership status.

In other countries, a debenture is a debt instrument that is not secured by physical assets. In these countries, debentures are backed by the creditworthiness of the issuer.

In the aforementioned countries, these debentures will be denoted as “unsecured.”

Rights Issue and Nil Paid Letters

After a company has been listed, it may have an opportunity to acquire one of its key competitors or to expand locally or across borders. When this occurs the company directors can decide to go back to the market for additional funding. If the directors decide to obtain additional funds from another issue of share and not from bank loans, they can offer shares from the company’s “authorized” shares. They have to make an offer of new shares to existing shareholders. These new shares belong to the company itself and are not issued from the directors’ personal shares.

This is called a “rights issue.”

This is carried out by offering their exciting shareholders the opportunity to buy some more shares in the amount that they already own. This way, major shareholders avoid their shareholding from being diminished. To execute this right, companies issue existing shareholders with “renounceable nil paid letters of allocation.”

Known as NPLs, they entitle these shareholders the right to buy one additional share for every share they own on a specific date, called the “take-up date.”

If a holder of NPLs does not take up the shares by this date, then the offer falls away and the NPLs have no further value. However, under such conditions, the shareholder has the right to sell these NPLs in the open market; already listed next to the company’s listed code. In this manner, new shareholders enter the market.

Some Investment Alternatives

The following are some of the more popular investment alternatives.

Fixed Interest and Other Bank Deposits

While bank deposits et al. have a place in the market, these are not investment opportunities.

Every trader should have at least 6 months’ worth of salary in a bank account, which should at least earn interest close to the inflation rate. Therefore, this is more of a short-term saving tool to meet a specific need, rather than an effort to achieve profit.

Therefore, while having a strong cash holding does not provide a trader with a real return, it does provide much needed stability for his daily trading activities.

Fixed Property

Large sums of cash are tied up for considerable periods of time. There is no doubt that over the past two decades property investors have made significant returns, but remember that such fixed assets usually require future additional capital outlays to maintain or improve the value of the property.

There are two additional issues that must be remembered:

Remember that property shares can always form a part of a portfolio of shares, which can be sold quickly when the property market turns; certainly quicker than trying to sell the actual property.

Entrepreneurial Endeavors

This risk of buying shares in an unlisted company is the lack or difficulty in an exit strategy.

This method is only desirable for investors who are prepared to wait indefinitely to recoup their investment. Large capital outlays are usually needed and often exclude the small investor.

The Bond (Gilt) Market

Also called gilts, bonds offer traders an alternative investment options. Note that these do not offer part ownership in companies or other organizations.

These tend to be issued by the state (i.e., parastatals and local municipalities), utilities (electricity companies, water providers, etc.), or companies.

Bonds are offered at a discount and pay a fixed rate of interest with a low associated risk. For instance, if a 5-year bond costs $1 million, has a 10 percent discount rate, and an annual interest of 15 percent, then a trader:

Although the nominal value of bonds remains constant, supply and demand influences prices.

While it may be expensive to buy bonds, the astute investor and trader would use bonds as a contra-cyclical strategy to equities. The alternative is to acquire a cheaper bond option or futures contract. Of course, bonds are also traded on the exchange.

The reason bonds are issued is to obtain funds to meet long-term financial commitments such as building roads, hospitals, providing electricity, or paying for large-scale mergers. The larger institutions, including insurance, mutual funds, and financial services companies, are the main purchasers of bonds.

Warrants (Also called Options)

A warrant is best explained as buying a claim on a share for its future value. These are divided into “call” and “put” warrants. The former is a claim that a share will rise and the latter a claim that the share will fall.

There are three main reasons for buying warrants.

An old colleague at the JSE, in early 2015, advised me to buy “put gilt warrants.” This means that he believed that the bonds market would be in a bull run within 6 months and that for every 100th of a percent that the gilt fell, I would earn R500. A mental calculation revealed that the gilt had to rise by only 200th of a percent for my investment to breakeven.

By the time I wanted to take up the warrant, it was too late. The gilt bull was in its zenith and the investment viability was lost.

The opportunity cost of not taking the risk of the venture became hypothetical and a hard lesson to learn. There are more ways of investing in the stock market than through the equity market. Take cognizance of all available securities, how you can benefit from them, take advantage of cross diversification, and open your mind to new methods.

In many instance, where novice traders need to learn the lesson of patience and focus, mentors will advise clients to buy warrants. The aim is to show such traders that warrants—at some point—will expire; fall to zero. As such, it is an important way to teach clients the ability to compare risk to reward as they have to continuously value their investment by looking at:

Let’s assess the preceding list.

This means that, if your analysis determines that, Stock A’s share price will rise (e.g., 120 cents) within 6 months before the warrant’s expiry date, then you would buy Warrant X to take advantage of the conversion rate of one warrant contract for 10 Stock A at the price of 105 cents.

The calculation would be to multiply Stock A’s share by the number of contracts you have taken, for instance if you bought 10 Warrants X, you would have bought 10 contracts. Then subtract the cost of the warrant and the decision would be yours to take up the conversion or not.

You could also trade the warrant as the price moves in the market. Note that you would only be “In the Money” once the share has moved past the strike price.

Share Installments

Share installments are effectively loans to buy shares.

They enable traders to optimize his or her exposure to the share market by making only a partial payment for their shares. For a portion of their current price, they get the benefit of ownership in the form of capital growth and dividends.

So, when you buy a share installment, you initially pay only a portion of the current share price, but the buyer is entitled to the same benefits that he or she or would enjoy had they bought the entire share.

By paying less upfront, you increase your share exposure by the gearing offered. If you want, you can pay the balance of the share price (i.e., the loan amount) at any time before the share installment matures, but this is not compulsory. If the share price falls you will not be subject to margin calls and you will not be required to repay the loan. As share installments are listed on some global exchanges, they are highly liquid.

Interestingly, share installments have some benefits over shares, namely:

The Futures Market

Despite being one of the most potentially profitable markets available to traders, it remains a highly misunderstood one. Analysts are unsure why these markets have not gained popularity in many emerging markets, but they guess reasons lie in understanding the complexities of new instruments. Although futures in the United States is mostly linked to actual commodities, such as orange juice, pork bellies or wheat, the trend is to link these to financial markets.

For instance, an investor could buy a futures contract—bull or bear—on the Petroleum Index. If he or she believes that the index will fall in the next 3 months, he or she can acquire a bear futures contract which will enable him or her to make money, despite a fall in the price of petroleum. In such an instance the investor has not bought actual petrol, but has bought the risk of movement in the price of that commodity. The greatest advantage of the futures market lies in the ability of investors to hedge and thus protect their investments against future market risks.

Spread Trading

Also known as Contracts for Difference (CFD) trading in the institutional marketplace, it is an alternative to traditional trading in equities. With spread trading you never take ownership of any stock. All you are buying is the price movement in the stock, or bond, currency or commodity.

One benefit of spread trading is that you can make money whether markets are rising or falling. You can buy a CFD on a security or index if you believe that it will a rise in price (called, going long) or you can buy if you believe the security or index will fall in value (called, going short).

One of the primary attractions of spread trading is gearing, which means that you have the potential to earn large profits on small movements in the underlying share, bond, index, commodity, or currency. Spread trading gearing levels range from about 6 times on individual stocks to 50 times on bonds and currencies.

You nominate the risk you’re prepared to take. For example, more conservative investors can nominate one dollar per point move the UK’s FTSE 100 index. More aggressive investors can increase this to $25 or even $50 per point.

In October 2015 I recommended that investors buy a CFD on Company X, which had announced that it was unbundling a division by separately listing that division, called Company Y. The forecast was that Company Y would list at $20 a share, which would reduce the share price of Company X to $80 a share. The analysis suggested that Company X share price would rise by at least $10 over a 3-month period.

With gearing, a $5,000 investment in a CFD equaled to $8 point movement for every 1 cent Company X share price moved. In the 5 days after the listing of Company Y, the share price rose by $6, which equaled to a profit of $4,800 on an investment of $5,000 (600 cents movement × $8 percent movement).

Stated differently, in 5 days investors made a 96 percent return on their $5,000 investment.

Unit Trusts

The aim of unit trusts is twofold:

Compared to investing in shares, the risk is lower, but should be considered as long term. The objective is to pay for a specialist to buy and manage a spread of shares for you. Although unit trusts usually provide real returns, they are a composition of blue chip shares and, therefore, often only reflect current stock market trends.

Gold Coins

The most popular gold coin is the Kruger Rand for South Africa, which is 22 carat bullion, weighing one troy ounce. It is considered a safe haven against bear trends in equities markets.

Other Less Liquid Markets

These include Persian carpets, coin or stamp collecting, antiques, and paintings. The investor relies on his or her knowledge of the item and its future potential value. The primary issue in making such investments depends on the investor’s knowledge or perception of the future value of new artworks.

The risk is great and often far exceeds the return. In addition, these have to be ensured at great expense.

Shareholders’ Rights

When you buy shares, a central securities depositary will record your name and various other personal details in an electronic register proving ownership of the shares. Once you own shares in a company, you have certain important rights, including:

Part 2, Chapter 5 explains Wall Street Rules to better trading techniques.