Investment portfolios

As a new investor on the market, I believe you will derive the most benefit and reward, as a conservative investor. So now we must decide what shares would fit into the needs of a conservative investor. There are more than 800 shares out there and you only want to invest in 8 at the most. Therefore you will discard many shares as unsuitable for yourself as a conservative investor.


What filter will you use to achieve this? As a beginning guideline, we will look at the guidelines used by the committee of the JSE, to choose shares to fit into the Actuarial Index.

1. A company is excluded if the whole or major portion of its operations are outside South Africa, unless accepted as being South African and included in the major institutions portfolios.

2. Where a company is largely a holding company, in general only the operating company is included.

3. If the volume traded has been small over the past few years, then the company is excluded.

4. Although some companies may choose not to pay out dividends, care is taken to ensure the unsound companies are excluded.

5. A company is excluded if a major part of its assets are shares in companies that have already been included.


A filter of this nature will set the scene for you with much of the work already done for you. The actuarial indices' book is available through the JSE at present date only costs, R20. The next reference work you will need is the JSE Handbook also at current cost of R20. This book has a complete list of companies listed on the JSE.

Now run through the Handbook and tick off all companies that have doubled their earnings in the last four years. The next filter to use is to cross off any share that has had a year in that period that it reduced earnings.

So far what we have tried to do is make sure you are investing in shares that are popular and that the institutions will buy, as today they (the institutions) are a large part of the market.

Shares in the 1960's had only 5% of the institutions' assets. Today this has grown to 60% of all their assets. By the mid 90's, it is likely that the institutions will be administering R230 billion within the market. This translates into over 40% of the market being in institutional hands.

The value of shares traded in 1989 was R20 billion and the top 20 shares traded represented 35% of the trade.

The institutions with their contractual savings from clients are allocating an increasing proportion of their cash flows to purchasing equities. So, it makes sense to follow where the market is, because it does not matter how good a company is, unless there are buyers, the price will not go up.

The aims and activities of an investor are to:

  • Buy in a low market and selling in a high market.
  • Buy carefully chosen "growth" shares.
  • Buy bargain issues.
  • Buy into special situations.

Buying low and selling high

The first approach needs much elaboration and will use the field of technical analysis (a field covered elsewhere in this book). At this stage it is imperative to look at historic earnings yields, to establish if you are entering the market at a very high level or not. It may pay to be patient and come in to invest at a later stage.

However we do not believe the long term conservative investor will concern himself with trying to read the market to determine if it is going up or down. He does not have the time, nor is able to glue himself to his investment tool's day in and day out.

Again we re-iterate that if the spread of investments is too wide he will only achieve results similar to the market. A well-chosen small group of shares can and will outperform the market. This is obviously subject to the time period involved.

If the industrial index earnings yield moves below 8%, the market tends to correct the market-price of shares very quickly. The market only allows share prices to trade in this area, for very short periods of time. We saw this in 1969, again in 72, again in 87 and may currently be in that area in 1992/93. This is not to say that we will be entering a bull market, since so many other factors (political and economic) also influence this tendency.

One must remember that earnings are historic and as a result in an improving economic cycle the increased earnings yields will lift the earnings and allow the market to keep on anticipating the earnings yields increase and thus expect the earnings yield to go up.

The market will not react to a decrease in earnings overnight and it is the sudden realization of the fall that could even accelerate the fall in market-prices. This is because the deteriorating earnings yield does not reflect the true position. An economic downtrend is usually well underway before we recognize it. So the individuals who think they can outsmart the market by buying low and selling high, will invariably close the door after the horse has bolted.

Growth stocks

Every investor would like to select stocks of companies that will do better than the average over a period of years. A growth stock is one that has grown well over a period of years and there is anticipation that it will continue to do this in the future.

It is logical that this is an area in which an investor must concentrate. This sounds easy, but it has many more problems than at first is apparent.

First you must realise that this approach will be the one that many other investors may adopt, so the price paid for the share will sell at correspondingly high prices. Even if you choose well, you may not fare well because you might have possibly overpaid for the shares to obtain them. The other reason is that the future may not produce the same returns to the company, since rapid growth is not an easy act to follow.

At some point the growth pattern will flatten out. The realization of this possible or probable outcome is the reason you must be wary of go-go companies and consider again companies with sustainable growth. The high growth shares are the shares that are most volatile and hence it is very easy to have overpaid to acquire them and then see large losses when they swing down.

You must be wary of a "growth share" that the market recognizes and which enjoys a very high earnings price ratio. This has injected a high element of risk into the share.

Having made these observations I still believe this is the only area a conservative investor will find shares that over a period of time will outperform inflation. By spreading his investment over a group of shares. The trap is not to expect things to happen right away, as they always take longer than you expect. Investing based on fundamentals eventually pays off.

The correct approach is to approach this as a businessman would, looking at a business to buy. In the same light realise that if you spread your investment too wide you are buying the market and will suffer the risks of the markets ups and downs.

To make a sound decision of whether to buy a business and that is what you are effectively doing when you buy a share, even though you do not have to manage the business, you will not only want to know the current position, but also as much history as possible. This information is readily available and if the company is slow in coming forward with current information, leave the share out.

Sifting strategies

Start with the Stock Exchange Handbook, with February and August updates each year.

List the following information for the last 4 years:

  • Turnover;
  • Net asset value;
  • High price;
  • Low price;
  • Earnings per share;
  • Dividend per share;
  • Current asset to liability ratio;
  • Debt %;
  • Number of shares in issue; and
  • Number of shares traded.

From here it is up to you to do some homework. Now it is not practical to look at all the shares on the market, so it is important to discard as many shares as possible. Start this by ticking off shares that have doubled their earnings and dividends in the previous 4 years, then cross off any share that has reduced earnings or dividend in the previous 4 years.

Now have a look at the debt, if this is too high and increasing, discard it. Have a good look at the turnover, is it growing or reducing, discard if necessary.

A more manageable number of shares will allow you to take a more comprehensive look at each one. Short term forecasts of the future are most unreliable and it tends to be unpredictable and anyone's guess. By contrast long term trends are virtually certain if you get your theory right.

As a result of all the sifting we have done, we now have a small group of shares to study, possibly 30. Now you need your calculator. You will need to work out some percentages. For example, what is the difference between the high of last year and the low of this year, to establish the volatility of the share. Soundly managed shares are not very volatile.

Work out the following:

  • % increase of turnover;
  • % increase of earnings;
  • % return of earnings to high price;
  • % return of earnings to low price; and
  • % increase/decrease of average price.

You will now be able to discern definite long term trends. So when you buy you will be able to see if the price you are paying is fair and once bought, you set up certain requirements as to why you bought and as long as the shares stay within your guide lines, you hold them.

The greatest advantage of the stock market is that if a business you bought is not living up to your expectations it is very simple to sell. You are then in a position to add to a successful venture, or look for another. Generally, unless a share has reduced its earnings it is best to hold it through the swings of market sentiment.

One of the things to remember is that a share with a very high growth in increased earnings will have a following that will push the share to higher prices than can be sustained by increased earnings, so you could be prudent at times to take your profit and buy into an increased-earnings share that can sustain the increases. This is an area where you will have to use your own discretion.


I am wary in giving you any formulas as there are thousands out there and your own experience will find which of those that suit you. When valuing a business, take the following two factors into consideration:

  • The actual value of its assets; and
  • The goodwill.

The accountants of a company will calculate the net asset value of a business, or share.

The market place will value the goodwill by possibly paying a higher price than the net asset value. This is quite reasonable as past performance and anticipated performance can earn goodwill. So the formula following, to determine the future value of a share, is only a guide line and you may adjust it to suit your personal views.

Take the current earnings of a share, take the earnings of a share two years ago. Let us assume the earnings have increased by 40% in the 2 years. First I take the current earnings and multiply this by 8.5. This is capitalizing the earnings at 11.76%, which is not very far off the valuation of a commercial property.

Now we are buying on the anticipation that earnings will increase, so it is important to allow a factor of goodwill or growth. To be conservative I take the increased earnings of the previous two years and divide this by 4. In this instance 40/4 = 10.

So to project the price my formula is (Earnings x (8.5 + 10)) in this instance, if the earnings per share were 25 the price projected would be:

25 x (8.5 + 10) = 462.

The price resulting from that formula should be the average price for the following year. This is a good calculation to do and can prevent investing in a share at too high a price.

Portfolio content

In selecting a portfolio along these lines, one has removed most of the individual risks, such as bad management, production setbacks, etc., that are specific to a share. Having minimized the specific risks, it is now wrong to subject yourself to market risks that are inevitable if you buy too many different shares.

In my opinion a private portfolio should not have more than eight shares in it, or less than four. If you have a computer and a spreadsheet program it is simple to capture the small amount of data on each share that you are studying and with a few spreadsheet calculations work out the earnings increases for one year, two years, three years, four years and so on.

Remember man at work = money. Money at work only = interest, but man working with money will = interest + capital appreciation.

Do not expect to be a successful investor on the stock market unless you are willing to work at it. In our modern world there is no such thing as buying a portfolio of shares and locking them away. You will need to examine how each of your shares is performing from time to time.

I have started here with the conservative investor and a portfolio for the conservative investor because this portfolio will require the minimum of management, if only to ascertain if profits have increased every six months.

The field of investment for the more enterprising investor would look at a different approach to the choice of portfolio and assume the investor had more time to devote to the management of his investments. The individual would then rely far more on the Technical analysis programmes mentioned earlier.

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