Top 5 key approaches to successful share market trading

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So you want to start buying shares but you’re not sure how to trade or you’re actively trading but not seeing the returns you had envision. Whether you’re new to the share market or not, it’s imperative to approach it with our top 5 tips on how to trade stocks.

#1 Identify key economic data globally and domestically that affect certain sectors

  • When an individual considers an investment in the stock market it is imperative that they employ a strategy, a plan of attack that has the potential to improve one’s chances of achieving share market success. One method of investing that has the potential to be highly effective is the ‘Top-Down’ investment approach.
  • ‘Top Down’ approach implores investors to take particular note of the global economic landscape before delving into the fundamentals of specific businesses. Investors need to identify economic themes and fundamental changes in the business landscape.
  • Investors need to identify economic themes and fundamental changes in the business landscape and focus attention towards market sectors that offer the brightest outlook. It is these sectors that will provide companies with the best opportunities to grow dividends and earnings.
  • In KOSEC’s opinion it pays for investors to be selective and slightly active when managing the makeup of their portfolios. Investors need to be bold at times eliminating exposure to certain sectors altogether regardless of the index weight. KOSEC (Kodari Securities) believes in diversifying but not over-diversifying just for diversification sake.


#2 Analyse critical company data and understand the business

  • In many ways we at KOSEC believe in keeping things simple. Following the simple structure of identifying sectors of the economy that are booming, before going a step further and selecting established businesses within those sectors that are financially sound.
  • There are over 2100 businesses on the Australian Stock Exchange (ASX) with less than half of those companies are profitable. In the investment committee meetings at Kodari Securities we use profitability as the base case for any investment opportunity. We then go a step further and aim to identify the businesses with sound and consistent financial metrics that forensically highlight a business’s profitability, operating efficiency, and liquidity over a meaningful period of time. Some of these metrics include headline figures such as Revenue and Net Profit, while ratios such as Return on Equity, NPAT margin, Net Gearing and Free Cash Flow all have powerful explanatory significance.

 

#3 Separate fact from rumor in the market

  • With the advent of the ‘internet of everything’ and 24 hour TV news channels, investors can find themselves inundated with superfluous and biased information. Debt crisis here, central bankers there, and the list goes on. At the end of the day investors need to strip investing back to its barest and simplest form.
  • After all the equity market is all about investing in quality businesses, not stocks. When you put your money into ‘stocks’, you are purchasing a complete part of a business, entitling you to a portion of that business’ future earnings stream and profits. Investors often lose sight of what it is they’re actually doing, distracted by the flashing lights and rapid number movements on their trading platform.

 

#4 Have an understanding of the key factors that drive share prices

  • A business with a sound balance sheet, a proven track record in their industry, and a management team that can maintain momentum going forward, can without doubt help. As a result investors achieve an annualised return comparable with any small cap business, while avoiding the sleepless nights in the process.
  • In order to demonstrate the power of investing quality established businesses in the right sectors, we can take for example the three companies that Kodari Securities has continuously recommended for the past 2 ½ years across numerous media streams whether it be on TV, in print, or through the KOSEC monthly reports.  The three companies are TPG telecom (Telecommunications sector); Domino’s Pizza (Food Retailing); and Ramsey Healthcare (Healthcare). We can the contrast these businesses with BHP.
  • By examining 5 year growth in the powerful explanatory variables of company Revenue; Earnings per share; Return on Equity; Dividends per share; Cash Flow per share, we can identify the chain of cause and effect, the business traits, which has ultimately led these companies to deliver significant outperformance in share price.
  • From the table below we can examine the 5 year growth in each of the key variables mentioned above, and the share price performance over that period. What we can see for this example is that businesses with growing revenues, earnings, return on equity, dividends and cash flows delivered share price growth. Conversely, BHP has delivered the inverse with its key metrics declining over a five year period a deterioration in quality that was reflected with a negative 42.93% return in share price.

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#5 Know when to buy and sell

  • Another common trap investors fall into is the habit of cutting their ‘winners’, while letting their losers run. There is some truth to the saying “you’ll never go broke taking a profit”, although it certainly is possible to have numerous winning trades but have one losing trade that leads to losses on a portfolio. For example assuming equal weighted trades, if an investor locks in a 10% profit on 9 different trades, but has a 90 per cent loss on one trade, then that single mishap can undo all the hard work and erase any profit.
  • It’s also worth considering that a 50% on an investment requires a 100% recovery in the same asset to square the books. Investors may therefore be best served by limiting their downside, while letting their winners run, and in any case it’s often the winners that are performing well for a reason.  
  • 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 years the share price performance has been anything but stable and safe.