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Tutorial 1 - Introductory topics

Tutorial 1 - Introductory topics

Executive summary

After reading through this tutorial, you should have a better understanding of what shares are, as well as what the different classes of shares are, what is a stock exchange, your rights as a shareholder and the reasons for investing in shares. You will understand how to calculate taxable income and what is capital gains tax. Finally you will understand what the difference is between fundamental and technical analysis, as well as know what things you should never do and how to choose your first shares.

What are shares?

As companies expand they often require additional capital to finance expansion projects. In order to raise necessary capital they often sell "shares" in the company to investors. Each "share" represents a portion of ownership in the company, normally entitling the holder to vote on important company matters and to receive dividends if dividends are paid. Investors who purchase shares are termed "shareholders". Shareholders may receive dividends if a company's board of directors declare that the company has made sufficient profits and that some of these profits should be returned to shareholders. Shares are also known as equities, stocks, securities, etc.

There is a direct relationship between the number of shares you own and your portion of ownership in the company i.e. the more shares you own, the greater amount of the company you own. Each share thus represents the amount of money which each individual investor has invested in the company. When the company makes a profit, each shareholder has a right to a share of that profit in proportion to the amount of shares which they hold. We refer to a slice of the company's profits as a "dividend".

What is the share price?

The share price is the price at which a particular share can be bought or sold. The share price is determined by supply and demand.

  • When you have more buyers than sellers, prices usually rise because shares are in demand.
  • When you have more sellers than buyers prices usually fall because it is easier to buy these shares.

If a company is very profitable, a share in that company will become more valuable because more people think that it is an investment. Factors such as the economic and political environment also influence share prices. How would you know which shares to buy? Enhance your knowledge of the share market through research. Do research through regular reading of financial literature, attending investment courses and seeking qualified experts' advice. This will enable you to make educated decisions on which stocks to invest in.

Different classes of share

One can distinguish between various classes of shares according to the manner in which they distribute dividends or interest:

  • Ordinary shares - Holders of ordinary shares have voting power and thus ultimate control over the company. For this advantage there is a penalty in the sense that ordinary shareholders have no right to the profits of a company until dividends are declared by the board of directors. In other words, each ordinary shareholder is entitled to an equal share of dividends as and when they are paid. In addition, on the winding-up of the company, holders of ordinary shares have only a residual claim against the assets of the company after the settlement of all other claims. Ordinary shares have no specific maturity date, no fixed income, are subject to great price volatility, and the holders thereof assume greater risks than holders of preference shares or debentures. The majority of shares listed on the JSE are ordinary shares. Companies usually issue ordinary shares when they commence business. Subsequent expansion plans often entail the issuing of other classes of shares.
  • Preference shares - Holders of preference shares have preference or 'first option' when dividends are declared and paid (i.e. have a prior right over all holders of ordinary shares in the distribution of dividends). Preference shareholders are guaranteed of specified percentage dividends if the company makes a profit. In addition, holders of preference shares have a prior claim to repayment of capital on winding-up of the company (i.e. paid out before ordinary shareholders). There are various classes of preference share, including cumulative, convertible, redeemable, participating, fixed or variable rate etc. Because the dividend rate on preference shares is usually fixed, the dividend is more regular and stable than on ordinary shares. However, preference shareholders have the disadvantage that they normally do not have any voting power. Who would buy preference shares? Investors that are looking for a hybrid debt and equity investment exposure or are looking for medium risk and return (risk is higher than debt instruments but lower than ordinary shares).
  • Debentures - Debentures are 'fixed-interest-bearing securities' issued by a company. It is generally viewed as a loan contract by the issuing company. The debenture represents a promise by the company to pay interest on regular intervals and to repay the capital amount at a specific future date/s. Thus debentures are akin to fixed bank deposits as they pay interest and not dividends. Debentures can be classified according to their security, term or yield. The various classes of debentures include fixed or variable interest, secured, unsecured, guaranteed, redeemable, convertible, participating, income etc.

Why invest in shares?

There are various advantages or benefits attached to investing in shares:

  • You do not need large sums of money to invest in the share market.
  • It is relatively quick and simple to liquidate any sums of money which you have invested in shares.
  • Shares entitle you to share in the profits of the company without the need to get physically involved in its day-to-day management.
  • As a shareholder you only share in the profits of the company - you are not responsible for any losses incurred by the company.
  • The risk to which one exposes oneself when investing in shares can be limited by following a sound investment approach. In fact, a sound investment approach, and the selection of quality shares will generally result in higher returns than endowment policies.
  • The exact value of your investment can be determined at any time.

In addition, the Exchange has various mechanisms aimed at providing additional protection to investors:

  • The imposition of strict membership requirements in terms of legislation and the JSE rules.
  • Ensuring the capital adequacy of its members.
  • The institution of monitoring systems aimed at the measurement and control of risk attributable to share market transactions.
  • The maintenance of strict procedures regulating the administration of discretionary account (where the broker manages your portfolio) monies.
  • The central automated trading system results in improved transparency, security and audit trails which greatly enhance investor protection.
  • The establishment of a JSE guarantee fund which serves to meet qualifying claims by investors in the event of default by a stock broking firm.
  • Fidelity insurance cover for individual broking firms against qualifying losses, including losses arising from fraud or theft of their own or a client's securities, or cash.

What is a dividend?

Whereas a bank deposit attracts interest, shares attract dividends. Dividends are paid out of a company's profits to shareholders. Dividends can be distributed in two ways, namely a cash dividend or a scrip dividend. A cash dividend is usually paid to a shareholder by cheque or bank transfer. Scrip dividends are dividends paid in the form of additional or new shares in the company instead of cash. A company would do this to conserve cash-flow.

The amount of a dividend is not fixed as it remains within the discretion of the directors of the company to decide what portion of the profits should be retained by the company for future expansion, and what portion is to be distributed as a dividend amongst shareholders. Listed shares generally declare dividends every six months. Mid-way through the financial year an interim dividend, based on the company's anticipated profits for the financial year under consideration, is declared and paid. At the end of the financial year, a final dividend is declared, based on the actual trading results for the full financial year. In addition shares offer another type of return, namely, growth of your initial capital investment. A share investor expects a relatively low dividend return to be enhanced by means of an increase in the share price. The opportunity for capital growth therefore generally holds more appeal to the average investor than does the prospect of an increased dividend distribution.

Management of a company may believe that the dividend money is best re-invested into the company for research and development (R&D), capital investment, expansion, etc. Proponents of this view and thus critics of dividends per se, suggest that an eagerness to return profits to shareholders may indicate having run out of good ideas for the future of the company. Some studies, however, have demonstrated that companies that pay dividends have higher earnings growth, suggesting that dividend payments may be evidence of confidence in earnings growth and sufficient profitability to fund future expansion.

Dividend dates to remember

Dividends must be declared (approved) by a company's Board of Directors each time they are paid. For listed companies, there are five important dates to remember regarding dividends.

  • The declaration date is the date on which the next dividend payment is announced by the directors of a company. This statement includes the dividend's size, ex-dividend date and the payment date. It is also referred to as the "announcement date". Once it is authorised, the dividend is known as a declared dividend and it becomes the company's legal liability to pay it.
  • The last day to trade (LDT) date is the last day (usually a Tuesday), which is one trading day before the ex-dividend date or response deadline date (usually the following Wednesday), where the share is said to be cum-dividend (with or including dividend). In other words, existing shareholders and anyone who buys it on this day will receive the dividend, whereas any shareholders selling their share lose their right to the dividend. After this date the share becomes ex-dividend.
  • The trading ex-dividend date (usually a Wednesday and typically two trading days before the record date) is the day on which all shares bought and sold no longer come attached with the right to be paid the most recently declared dividend. This is an important date for any company that has many shareholders, as it makes reconciliation of who is to be paid the dividend easier. Existing shareholders will receive the dividend even if they now sell the share, whereas anyone who now buys the share will not receive the dividend. It is relatively common for a share's price to decrease on the ex-dividend date by an amount roughly equal to the dividend paid. This reflects the decrease in the company's assets resulting from the declaration of the dividend. The company does not take any explicit action to adjust its share price; in an efficient market, buyers and sellers will automatically price this in.
  • On the record date (usually the following Friday), a company determines who its shareholders are and to see who is entitled to receive a dividend or distribution. Essentially, a date of record ensures that the dividend payments get sent to the right people.
  • The payment date is the day (usually the following Monday) when the dividend cheques will actually be mailed to the shareholders of a company or credited to brokerage accounts.
Special dividends

A special dividend, according to Wikipedia, is a payment made by a company to its shareholders that is separate from the typical recurring dividend cycle, if any, for the company. The difference may be the result of the date of issue, the amount, the type of payment, or a combination of these factors. The amount of the dividend is declared special in relation to the share price. For this reason, the ex-dividend date is set one trading day after the payment date. The share will trade on an ex-distribution basis, adjusted for the amount of the dividend paid one trading day after the payment date. The determining factor for a special or significant dividend is usually when the dividend is 20% or greater in relation to the underlying price of the share.

Source:https://en.wikipedia.org/wiki/Special_dividend

Dividend tax

Dividend Withholding Tax (DWT) is a tax charged at 20% on shareholders (i.e. beneficial owners) when dividends are paid to them. This tax is withheld or subtracted from their dividend payment by a withholding agent or regulated intermediary such as your stockbroker.

What is a stock exchange?

A stock exchange is the forum or market place where shares, in listed companies, are bought and sold. A company is "listed" on a stock exchange and shares are issued therein. Investors have an opportunity to acquire a portion of the ownership in such company through the purchase of shares. Proceeds from such purchases are normally used by the company to finance expansion projects or reduce debt. Investors can similarly divest themselves of their 'ownership' by selling such shares to other investors. This allows the investor to realise some profit should they be able to sell the shares at a higher price than what they originally paid.

There are stock exchanges all around the world, for instance, in London, New York, Hong Kong, Sydney, Nairobi etc. The stock exchange in South Africa is the Johannesburg Stock Exchange (JSE).

The JSE consists of two markets which carry on their business side by side. These are the:

  • "Primary Market" where companies and other organisations sell their shares to the public in order to raise funds; and
  • "Secondary Market" where members of the public buy and sell these shares between themselves.

Once a company has sold its shares to the public in the primary market it derives no further direct benefit from the trading of its shares in the secondary market. It is, however, essential to have a healthy secondary market before the sale of shares in the primary market can be successful. After all people are usually unwilling to buy shares from a company unless they know that they could sell them again in the secondary market if they wanted to.

The role of the Johannesburg Stock Exchange (JSE)
  • The JSE provides a regulated trading platform where buyers and sellers trade;
  • The JSE protects investors through its rules and regulations and guarantees all trades transacted on the JSE;
  • The JSE provides a wide choice of companies and products for the investor to invest in; and
  • The JSE provides an active and liquid market.

Where does a company source capital?

A company obtains its capital in two ways:

  • From shareholders; or
  • By borrowing.

Shareholders contribute capital in exchange for shares. Traditionally, companies have borrowed money from banks. However, companies can borrow directly from investors and issue a certificate, which acknowledges the loan. This certificate is a bond that promises to pay interest, usually at a fixed rate, and repay the capital at a stated future date. When a bond reaches the end of its term it is said to have matured. This repayment of capital is called redemption of the bond. The investor can hold the bond until maturity or he can sell the bond to another person. Shares do not mature. Shareholders can only sell their shares to another person.

Requirements for listing a company on the main board of the JSE

Only public listed companies can trade their shares on the stock exchange. It is therefore important to be able to distinguish between a public and private company:

  • A private company (Pty limited) is a separate legal entity that has to register as a tax payer in its own right. A private company has a separate life from its owners and is required by the Companies Act, No 71 of 2008 to perform rights and duties of its own. The Act distinguishes between two main categories of companies, namely profit and non-profit companies. A profit company is incorporated for the purpose of financial gain for its shareholders, while a non-profit company is incorporated for public benefit.
  • A public company may raise capital by offering shares to the public and must have a minimum of 7 shareholders - there is no maximum. Public companies' names are followed by the word "Ltd".

Before a company can be listed on the "Main Board" it must meet the following requirements:

  • Have at least three years of satisfactory audited profit history, with a current pre-tax profit of at least R15 million and after taking account of the headline earnings adjustment on a pre-tax basis.
  • Have a minimum of R50-million in subscribed capital with not less than 25 million shares in issue.
  • 20% of each class of equity shares must be publicly held to ensure liquidity.
  • The JSE may list companies which do not strictly comply with the above requirements, but this will only occur in exceptional circumstances.
  • It should be noted that investment entities, mineral companies and property companies that are listed on the Main Board have certain modified criteria for listing.
Listing requirement for AltX

In addition to the Main Board requirements, a company wishing to list on AltX must comply with the following requirements:

  • Must appoint a designated adviser.
  • Must have share capital of at least R2 million.
  • 10% of each class of equity shares to ensure reasonable liquidity.
  • Directors must have completed the AltX Directors Induction Programme.
  • Must appoint an executive financial director and the audit committee must be satisfied that the financial director has the appropriate knowledge and expertise.
  • Must produce a profit forecast for the remainder of the financial year during which it list and one full financial year thereafter.
  • The company’s auditors or attorneys must hold in trust 50% of the shareholding of each director and designated adviser from the date of listing.

SETS

The JSE trading floor closed on the 7th June 1996, and has been replaced by an automated system for trading in shares. After this date orders from investors to buy are now matched with orders from investors to sell. At first this was done via the JSE's computerised trading system, the Johannesburg Equities Trading System (JET). The JET System was designed by the Chicago Stock Exchange and has been successfully employed in various other markets. From the middle of 2002 the JET system was replaced with the London Stock Exchange's (LSE) automated trading system, SETS.

This order-driven centralised automated trading system can be described as "on-screen trading floors" operated by dealers entering buy and sell orders into the trading system via remote terminals or workstations. Whilst there are some physical differences between the mode of operation of a trading floor and an automated process, they are in essence the same conceptually.

Significant improvements arise for investors, listed companies and the JSE itself from SETS through improved transparency, security and audit trails which greatly enhance investor protection. Increased capacity and real-time surveillance capabilities using comprehensive audit trail and analytical techniques are special features. Although the differences appear to be minimal, the great change is that brokers are now allowed to acquire shares and sell them to their clients. In other words, the broker can now act as a "principal", whereas in the past he could only operate as an agent. Most brokerage houses have, however, chosen not to act as principals.

Trading hours are currently from 09h00 to 17h00, but it can be expected that these will be extended to tie in with certain overseas markets.

How does trading take place?

The share price is the price at which a particular share can be bought or sold. The share price is determined by supply and demand.

  • When you have more buyers than sellers, prices usually rise because shares are in demand.
  • When you have more sellers than buyers prices usually fall because it is easier to buy these shares.

If a company is very profitable, a share in that company will become more valuable because more people think that it is an investment. Factors such as the economic and political environment also influence share prices. Dealers manage their orders through a centralised order "book" by entering their buy and sell orders into the book via trading workstations linked to SETS. The orders are immediately included in the summary display showing the aggregate of the orders in the order book for all dealers to view. If a dealer has not entered his order in the book he may not partake in trading.

The central order "book" is thus the cornerstone of the trading system and appears on each trader's screen as follows:

Order Book – ABC Ltd

Buy (Bids)

Sell (Offers)

Quantity

Price

Price

Quantity

6 000

99

101

15 000

5 500

98

102

1 000

12 000

97

103

17 000

The order book is divided into two sides:

  • On the left there is a buy or bid column which lists buying orders from the highest price at the top left to the lowest price at the bottom left.
  • On the right there is a sell or offer column which lists selling orders from the lowest price at the top right to the highest price at the bottom right.

The order book is organised on the principle of "price and priority" where orders when registered in the book are ranked first at the best price and then in time sequence of entry. Thus, the first order entered at a specific price has priority over late orders at the same price.

The above order book can now also be viewed by private clients via an online broker. Furthermore, by making use of an online broker, clients are able to enter and manage their orders themselves.

Thus the buy orders making up the 6 000 shares at 99 cents in the above example, consist of for instance:

Time Placed

Quantity

9:35

3000

10:05

3000

The SETS System continuously attempts to match the bids and offers, comparing the orders and generating trades whenever the terms of the orders match. Those orders which can be matched (fully or partially) by an opposing order are automatically traded. The dealers are advised of the trade immediately following matching. For example a member firm enters a sell order of 5 000 shares @ 99 cents:

Order book – ABC Ltd

Buy (Bids)

Sell (Offers)

Quantity

Price

Price

Quantity

6 000

99

99

5 000

5 500

98

101

15 000

12 000

97

102

1 000



103

17 000

The highest priced buy orders and lowest price sell orders are matched first. In other words, the sell order for 5 000 shares @ 99c is matched with the buy orders of 6 000 shares @ 99c, and the shares are automatically traded, taking into account the time sequence of entry of the sell orders.

The status of the order book after execution of the orders is then as follows:

Order book – ABC Ltd

Buy (Bids)

Sell (Offers)

Quantity

Price

Price

Quantity

6 000

99

100

15 000

5 500

98

101

1 000

12 000

97

102

17 000

Thus the outcome is as follows:

  • One member firm has purchased 3 000 shares @ 99c
  • Another member firm has purchased 2 000 shares at 99c and remains a buyer of 1 000 shares (3 000 - 2 000) @ 99c
  • A third member firm has sold 5 000 shares @ 99c

Good-till-cancelled (GTC) Orders - This is a time restriction that you can place on different orders. A good-till-cancelled order will remain active until you decide to cancel it. PSG Securities Ltd typically limits the maximum time you can keep an order open (active) to T + 7 (i.e. Trade plus seven days) and T+ 30-days (i.e. Trade plus thirty days) maximum.

Good for the Day Orders - If, through the GTC instruction, you do not specify a time frame of expiry, then the order will typically be set as a day order i.e. only for today. This means that after the end of the trading day, the order will expire. If it is not transacted (filled) then you will have to re-enter it the following trading day.

Who is a stockbroker?

Unlike other markets where the buyers and sellers are almost always different people, on the JSE the same people buy and sell shares but you, as a private individual cannot trade directly on the JSE. To buy or sell shares on the Johannesburg Stock Exchange (JSE) you need to go through an authorised trader or stockbroker. Only members or their nominated representatives are allowed to buy and sell shares on the Stock Exchange. A member of the JSE is called a "stockbroker". Both natural persons and institutions (since November 1995) are permitted to become members of the JSE. Because only stockbrokers are allowed to buy or sell shares on the JSE, the first step in buying or selling shares is to choose a stockbroker through which to deal.

Although the distinctions are often somewhat arbitrary, the activities of a broker can be divided into six main categories:

  • Investment researcher;
  • Client adviser;
  • Trader;
  • Portfolio manager;
  • Corporate financial adviser; and
  • Administrator.

A stockbroker should be selected with the same amount of care as you would apply to choosing any other professional adviser. The most effective way is by personal introduction or by recommendation from one's attorney, accountant or bank manager. Be aware of the fact that brokers are not in business for charity. With this in mind, most brokers are not overjoyed by the prospect of taking on smaller clients. The advent of the online stockbroker has changed this, most online brokers take on any clients, and size does not have any effect. In view of the fact that he will have a significant role in handling your financial affairs, it is vital that he suits your professional and personal needs. With this in mind you should be aware of the various ways in which stockbrokers offer their services, and the advantages and disadvantages attached thereto:

Agent: Direct settlement - Here the broker simply acts as your agent by buying and/or selling shares on your behalf, upon your instructions. Generally speaking, such transactions are by verbal agreement. You simply instruct the broker, in person by telephone, or online, which shares you wish to buy and/or sell or what the minimum price is which you are prepared to accept or pay per share is. Shares bought in this manner are registered in your own name.

When buying you are generally required to settle (i.e. make full payment) within three working days (T+3) from the date of the transaction. Although this is the cheapest method of share-dealing, it is not without its disadvantages - investment advice is usually minimal, you are responsible for all administrative tasks (e.g. following up on dividend payments), and you have to keep abreast of the current market situation yourself.

Note: As of 11 July 2016, the JSE reduced the settlement period to the trading day plus three days (T+3). In other words, when buying a share you are generally required to settle (i.e. make full payment) within three working days (T+3) from the date of the transaction. This was to align its settlement period with global standards. This also resulted in a number of benefits for the South African market, including increased liquidity and a reduction in credit and systemic risk. The new T+3 settlement period is a JSE-mandated, regulatory requirement and applies to all equity market trades.

Agent: Settlement with bank - Here the broker also merely acts as an agent, but the one major difference is the reduction in administration. Administrative tasks are passed on to the bank by instructing it to settle with the broker. Upon purchase of shares on your behalf, the bank settles directly with the broker by debiting your current account. The bank also ensures delivery of the transfer deeds as well as the collection or dividends. In addition, one has the choice of having the shares registered in one's own name or authorising the bank to register the shares in the name of its nominee company. The major disadvantage in this method is that bank charges tend to be quite expensive - delivery, safe custody, dividend collection and registration are all charged.

Managed client - This system provides one with two options.

  • One can give one's broker non-discretionary authority to hold cash and shares on one's behalf but not to make investment decisions: or
  • One can give one's broker total discretion to manage your portfolio on your behalf.

Non-discretionary client - In the case of a non-discretionary client, shares and cash are handed over to the broker. All cash balances are automatically deposited with the JSE Trustees (Pty) Ltd on call. These balances normally earn a higher rate of interest than on call deposits with other institutions. All shares purchased are registered in the name of the broker's nominee company and deposited with a registered commercial bank for security purposes.

The JSE STRATE system means that shareholders will receive regular statements rather than share certificates, eliminating the possibility of tainted scrip entering the market. Brokers no longer have to wait for the arrival of share certificates from a seller before a deal can be settled and dividends and other cash benefits will be paid electronically into shareholders' trading accounts.

Discretionary client: Fully managed portfolio - Here the portfolio is handed over to a broker. You will be sent monthly statements and income cheques but will have minimal control over share selections, as the broker will make your investment decisions for you. This is the most expensive form of share dealing. Contact with your broker is usually by way of telephone or online. Verbal contracts are legal and binding as evidenced by the JSE motto: "My Word Is My Bond"

Dealing costs

You do not need a lot of money to start investing as there are products available to private investors at affordable prices. Some products, like Exchange Traded Funds (ETFs), offer investment plans where a monthly debit fee or once-off lump sum investment can be paid. It is best to consult with a stockbroker about the relevant transaction fees involved. There are various costs involved when buying or selling shares:

  • Brokerage - This refers to the fee which goes to the broker who buys or sells shares on your behalf (i.e. acts as your agent). Deregulation and automated trading have radically altered the situation in relation to brokerage costs. Dealing charges are calculated using the following sliding scales. Brokerage Sliding Scales excludes VAT

Consideration

Online scale

Minimum

R 98

Below R 25,000

0.9%

R 25,000 to R 100,000

0.85%

R 100,000 to R 250,000

0.75%

R 250,000 to R 1,000,000

0.5%

R 1,000,000 +

Negotiable

Investors must also be aware of the following mandatory cost and charges that will be levied on transactions:

  • STRATE settlement costs of 0.005787% of the value of shares traded (with a minimum of R11.58 and a maximum of R57.87)
  • Investor protection levy of 0.0002% of the value of shares traded.
  • VAT of 14% is payable on the brokerage, the settlement costs and the protection levy.
  • STT (Securities Transfer Tax) is charged at 0.25% on the value of share traded, but is levied only on share purchases. (i.e. no STT when shares are sold).

Practical example 1 - Buying Shares - An investor wishes to buy 1 000 shares at R15/share. Assume that the stockbroker charges the following fees, at the following rates:

  • A brokerage fee of 0.90% on all amounts below R25 000 (according to sliding scale).
  • 14% VAT on brokerage fee
  • Securities Transfer Tax at a rate of 0.25%

What will the investors total dealing costs be?

1.

Value of specific transaction

1 000 x R 15

= R 15 000.00

2.

Brokerage

(0.90% x R 15 000)

= R 135.00

3.

Plus 14% VAT on brokerage

(14% x R 135)

= R 18.90

4.

Plus STT

(0.25% x R 15 000)

= R 37.50


Equals Total Cost (i.e. Brokerage, VAT and STT)


= R 191.40


Total Buying Cost


= R 15 191.40

Practical example 2 - Selling shares - An investor wishes to sell 5 000 shares at R 25/share. Assume that the stockbroker charges the following fees, at the following rates:

  • A brokerage fee of 0.90% on all amounts below R 25 000 (according to sliding scale).
  • 14% VAT on brokerage fee
  • No STT on selling!

What will the investors total dealing costs be?


Value of specific transaction

5 000 x R 25

= R 125 000.00


Transaction charge equals...







1.

Brokerage sliding scale (0.90% x R 25 000)


= R 225.00


(R 25 000 to R 100 000 = 0.85% X R 75 000)

= R 637.50


(R 100 000 to R 250 000 = 0.75% x R 25 000)

= R 187.50


Total brokerage charges


= R 1 050.00





2.

Plus 14% VAT on brokerage (14% x R 1050)

= R 147.00






Equals total selling costs


= R 1 197.00

Rights of a shareholder

When you invest in the shares of a company you are entitled to certain rights and privileges, namely:

  • You have the right to receive dividends should dividends be paid.
  • You have the right to vote (ordinary shareholders) at all general and shareholder meetings, and may even force the company to convene a meeting under certain circumstances.
  • You have the right to equal treatment at all times, regardless of whether you are a controlling or minority shareholder.
  • You are entitled to competence, integrity and honesty from all company directors.
  • You are entitled to be kept informed of any relevant information regarding your investment. This is usually done through the Stock Exchange News Service (SENS) or the financial press.

What are the risks associated with investing?

Investing on the stock market is riskier than some other investments. You are taking a risk in buying an ordinary share that is greater than putting your money into a bank fixed deposit. Because of this, you should be rewarded for taking that risk. As you would expect, the more risky a company, the higher the return you must look for before you buy it.

Risk and return should rise together.

Measuring your return is easy, as your investment in shares is divided into capital gain, which is the difference between your buying price and your selling price, plus your dividend. Usually, the sum of these two is expressed as a percentage of the price you paid for the share, and annualised.

For example, if you have bought a share for 1000 cents, sold it six months later for 1500 cents and taken a dividend of 50 cents in the middle, then your total return is 550 cents or 55% made in six months - which is an annualised 110% rate of return.

The two principles governing the return on investment are:

  • The greater the risk, the greater the return expected by investors;
  • The longer the money is tied up, the greater the return expected by investors.

Measuring your risk is much harder to do, and for this reason most investors leave it to their "gut-feel". The risks associated with investment are various and can be categorised in different ways. The main risks are:

  • Market risk - a share price falls as a result of a fall in the stock market generally;
  • Investment specific risk - a share price falls as a result of some event or circumstance specific to that company;
  • Interest rate risk - a share price falls as a result of a rise in interest rates;
  • Default risk - the investment becomes worthless, e.g. the company becomes insolvent, the share is suspended and the listing is terminated; and
  • Inflation risk - the real value of the investment and the income from the investment fall as a result of inflation.

There is probably no investment that is entirely risk free. Even Triple A-rated government bonds, which are among the safest form of investment, are affected by inflation. One of the objectives in constructing a portfolio is to determine the level of risk which is acceptable to the investor, and to then maximise the return for that level of risk. Risk can be regarded as a scale with government bonds at the very safe end and speculative, unquoted shares and derivatives such as single stock futures and CFDs at the very risky end.

How can you manage risk?

You can minimise your investment risk by diversifying your investment. You should avoid putting all your eggs in one basket. Consider choosing your investments from a variety of sectors, companies and investment products. Do research on the stock market through regular reading of financial literature, attending investment courses and seeking qualified experts' advice. Be committed to your investment objectives. Determine the investment period you are prepared to wait for a return on investment and be patient. If a share does not perform you may need to review your strategy. Determine your risk profile and look for products that you are comfortable with. Consult a stockbroker if you need additional advice. Invest with money that you can afford to lose, i.e. your disposable income after all your needs have been taken care of. Although investing allows you to make a good profit you should also be prepared for the risk involved in losing your money.

We can look at risk in terms of two main types of risk:

  • Diversifiable risk, which we can call investment specific risk, and
  • Undiversifiable risk, which we can call market risk.

Therefore,

Total Risk - Diversifiable risk + Undiversifiable risk

Total Risk - Investment Specific Risk + Market Risk.

Market risk is the risk of market movements or market segment movements. For example, the Asian Crises that affected the world financial markets caused many share markets to fall heavily. It cannot be diversified away.

Investment specific risk reflects factors specific to the company. For example, Rainbow Chickens were affected by the Newcastle disease that killed most of their chickens. This situation can be eliminated or reduced by a well-diversified portfolio.

The two techniques for managing risk are:

Tax implications

The tax implications of undertaking, altering or disposing of any investment must be considered in order to arrive at a "net after-tax rate of return". In South Africa income tax is levied in terms of a statute known as the Income Tax Act 58 of 1962 (hereinafter referred to as 'the Act'), as amended, and various regulations passed in terms thereof.

The Act levies a number of taxes. First and foremost, it levies a tax upon taxable income, known as "normal tax", upon all persons who derive income from sources within or deemed to be within the Republic: In the case of companies, the tax is a flat rate of 28%. In the case of all other persons (individuals, estates, trusts, investment clubs etc.) the tax is imposed at a progressive block rate, with low taxable incomes attracting a lower rate than higher taxable incomes.

The current tax rates are as follows:

Tax rates for individuals (tax year ending 28 February 2018)

Taxable Income (R)

Rates of tax (R)

R 0

R 189 880

18% of taxable income

R 189 881

R 296 540

R 34 178 + 26% of taxable income above R 189 880

R 296 541

R 410 460

R 61 910 + 31% of taxable income above R 296 540

R 410 461

R 555 600

R 97 225 + 36% of taxable income above R 410 460

R 555 601

R 708 310

R 149 475 + 39% of taxable income above R 555 600

R 708 311

R 1 500 000

R 209 032+ 41% of taxable income above R 708 310

R 1 500 000 and above R 533 625 + 45 of taxable income above R 1 500 000

Source: www.treasury.gov.za

Calculation of taxable income

The normal tax is levied upon the "taxable income" received by or accrued to or in favour of any person during the year of assessment. The Act provides for a series of steps to be taken for the purposes of arriving at the taxable income.

The starting point is "gross income" i.e. the total amount, in cash or otherwise, received by or accrued to or in favour of any person during the year of assessment from a source within or deemed to be within the Republic, excluding receipts or accruals of a capital nature but including the receipts and accruals specified in the definition, whether of a capital nature or not. In the case of persons other than companies, the year of assessment covers the period 1st March to the 28th February.

From 'gross income' are deducted all "exempt income" i.e. all receipts and accruals which are in terms of the Act exempt from tax, and the result being 'income'.

From 'income' are deducted all "deductions" i.e. amounts allowed to be deducted or set off under the act, the result being "taxable income".

The framework for the computation of Taxable Income can thus be summarised as follows:


GROSS INCOME

XXX XXX

Less

Exempt income

(XXXXX)


INCOME

XXX XXX

Less

Deductions

XX XXX


Taxable Income

XX XXX

The tax rate applicable to the resultant amount of taxable income is then applied in order to calculate how much normal tax is payable.

Practical example

A taxpayer has the following receipts and accruals during a year of assessment:

1

Proceeds of sale of private residence (capital receipt)

R 40 000

2

Income from a non-Republic source

R 1 000

3

Receipts from a business carried on in South Africa

R 18 000

4

Interest from a Post Office Savings Account (exempt)

R 200

5

Gross Income

R 59 200

His total expenses in connection with his business are R 2 000.

His taxable income is determined as follows:

Total receipts

R 59 200

Less: Capital receipt

R 40 000

Income from non-Republic source

R 1 000


R 41 000

Gross income

R 18 200

Less: Exemptions


Interest from savings

R 200

Income

R 18 000

Less: Deductions


Business-related expenses

R 2 000

Taxable Income

R 16 000

Normal tax is at the prescribed rates is calculated on R 16 000 (i.e. 0 – 189 880 x 18%) = R 2 880.

Gross income definition

It will be seen from the previous summary that the basic element in the determination of normal tax is 'gross income' i.e. the...

  • Total amount;
  • In cash or otherwise;
  • Received by or accrued to, or in favour of, a person;
  • From a South African source (or a deemed South African source);
  • Other than receipts or accruals of a capital nature.

It is the final element of the gross income definition which is of the greatest interest to us.

In CIR v Stott 1928 AD 252, the taxpayer, an architect and land surveyor, had made a number of investments in land over a period of 20 years. In 1920 he purchased 54 acres of coastal land, with the primary intention of building a seaside residence thereon. Later, he sub-divided the property, retaining the half with the house, and divided the other half into lots which he then sold off at a profit over the next few years. In 1921 he bought a small fruit farm which was subject to a long lease. On the lessee's breach, the taxpayer cancelled the existing lease and re-let the farm subject to his right to sub-divide the land and sell it in lots, which he subsequently did at a profit. The Commissioner included the proceeds of the sale of both the coastal land and the farm in the taxpayer's gross income.

The Special Court upheld the Commissioner's assessments on the basis that by dividing the land into lots and selling them at a profit the taxpayer had changed his original intention in acquiring the land and had embarked on a scheme of profit making. The NPD, having reversed the decision of the Special Court, held that the proceeds were accruals of a capital nature. The Commissioner appealed to the AD.

Wessels JA stated that in determining whether the proceeds derived from the sale of an asset are of a capital or revenue nature, the intention with which the asset was acquired is an important factor. In addition, that unless some factor intervenes to change such intention, then such initial intention is conclusive in determining whether the proceeds from its sale are of a capital or revenue nature. The court held that to convert what was an ordinary investment into a profit making business, there had to be proof of some special acts which show that the taxpayer had embarked on a scheme of profit-making. Wessels JA held that on the evidence, both the coastal and farm land were bought as an ordinary investment of surplus funds, and further that there was no evidence to show that the taxpayer had changed his initial intention. The conclusion in the Stott case that the intention with which the asset was acquired is an important factor, unless some factor intervenes to change such intention raises the question of what constitutes 'some factor'?

In Natal Estates Ltd v SIR 1975 (4) SA 177 (A) a company, whose business was the growing of sugar cane acquired land with the intention of using the land to cultivate sugar cane (i.e. held for purposes other than profit making). When the company was subsequently taken over by new shareholders, the land was sold for a profit. Prior to the transaction steps had been taken to develop the land. The court had to determine whether the proceeds acquired from such sale were of a capital or revenue nature.

Holmes, JA reiterated the judgement of Wessels in Stott, holding that the mere fact that a taxpayer realises an asset to his best advantage doesn't mean that the sale proceeds are of a revenue nature, and that additional factors must be present in order to come to such a determination. He set out a number of factors which can be taken into consideration in establishing intention, but warned that when deciding whether the taxpayer embarked on a scheme of profit making one must take into account all the facts, that no factor is individually conclusive, and that the list of facts is not exhaustive. The court concluded that the taxpayer's intention had changed from an intention to hold the land as a capital asset to embarking on a scheme of profit making. Thus, the proceeds were held to be of a revenue nature, and thus subject to tax as part of the company's gross income.

What about the situation where the taxpayer holds the asset with mixed intentions? For example: When a second hand car dealer buys a second hand car with the intention to both use it to travel to and from his place of work (i.e. in a scheme other than profit making) and to use it as trading stock in his business (i.e. in a profit making scheme).

In such instances there are two possible solutions:

  • Determine which the dominant intention is and apply the relevant principles; or
  • If no dominant intention can be determined, apportion the income between revenue and capital.

In determining the intention of the taxpayer, the following factors, inter alia, can be taken into consideration:

  • The business he undertakes
  • The length of period he held the asset (long = capital)
  • The taxpayer's oral evidence about his own intention
  • The use to which the asset was put whilst held
  • The reasons for sale and decline of previous offers
  • The use of the proceeds
  • The age of the taxpayer
  • Past similar transactions

Hold your shares for three years

Investing takes time and patience and that the chances of a good return are increased the longer the investment horizon. From an income tax perspective there is also an incentive to hold shares for at least three years before selling them because of the "safe haven" tax rules contained in section 9C of the income Tax Act. It provides that the proceeds from the sale of shares (with certain exceptions) are automatically deemed to be capital if held by the taxpayer for at least three years.

This means that the more favourable capital gains tax (CGT) rate (a maximum rate of 18%, as opposed to the income tax rate of a maximum of 45%), will apply to profits made on shares that are held for three years or more. When shares are held for less than three years the normal rules governing capital gains versus income gains must be applied to determine whether the gain is capital or income in nature:

  • If the gain is capital in nature the capital gains tax rate will apply; and
  • If it is income or revenue in nature the income tax rate will apply.

Source: For more on taxation regulations see the South African Revenue Service website

Income or capital

If you hold a share as trading stock (that is you bought it for the main purpose of reselling it at a profit), any gain or loss on disposal will be of a revenue nature. Revenue gains are subject to income tax at your marginal tax rate, which may vary between 18% (but effectively 0% if your tax rebates are taken into account) and 41%, depending on the level of your taxable income.

On the other hand, if you hold a share as a capital asset (that is, as a long-term dividend-producing investment) any gain or loss upon the disposal will be of a capital nature. Capital gains are subject to tax at a lower rate than ordinary income. In the case of an individual, the first R 40 000 of net capital gains or losses in a tax year is exempt for CGT purposes (known as the "annual exclusion"). Of the balance, 40.0% is included in your taxable income and taxed at your marginal tax rate in the same way as, say, your salary or pension income.

The effective rate of tax on an individual's net capital gains in a tax year can thus vary between 0% and 16.4%, namely:

  • The 0% rate would apply when the capital gains do not exceed the annual exclusion, or your taxable income falls below the level at which tax becomes payable;
  • The 18% rate would apply when your marginal tax rate is 45% (that is, 45% x 40% = 18%)

Capital gains on the disposal of assets are included in taxable income with the maximum effective rate of tax:

  • Individuals 18%
  • Companies 22.4%
  • Trusts 36%

Events that trigger a disposal include:

  • A sale;
  • A donation;
  • An exchange;
  • A loss;
  • Death; and
  • Emigration.

The following are some of the specific exclusions, namely:

  • R 2-million gain/loss on the disposal of a primary residence or the disposal of a primary residence for an amount of R 2-million or less;
  • Most personal assets;
  • Retirement benefits;
  • Payments in respect of original long-term insurance policies;
  • Annual exclusion of R 40 000 capital gain or capital loss is granted to individuals and special trusts; and

Instead of the annual exclusion, the exclusion granted to individuals is R 300 000 during the year of death.

Case studies

There is a large volume of legal precedent governing the distinction between capital and income gains and the approach of the courts has been to place much emphasis on the intention with which the taxpayer acquired the shares, namely

  • Was the dominant purpose for investment (capital); or
  • Was it for speculation (income)?

Speculation concerns the subsequent sale of the shares at an increased price, while investment is the holding the shares more or less for keeps in order to earn dividend income. However, a potential problem that a taxpayer faces with regard to the argument that he acquired shares in order to earn dividend income is that the dividend yields of shares on the JSE are usually extremely low and it is often difficult to argue that this is a rational investment strategy.

South Africa's strongest case law on this issue, much of which was decided in a time when dividends were relatively higher, would certainly not prove helpful to a taxpayer who, in addition to earning dividend income, sought to bolster the performance of the share portfolio by selling at a profit to any meaningful degree.

In the case of Tod, which was decided in the then Natal Provincial Division of the High Court in 1983, the taxpayer was retired and lived almost entirely on the dividends from his shares. Tod had embarked on a plan to increase his annual dividends whereby he would purchase a share on which a dividend was imminent and as soon as the dividend had been declared he would sell the share, usually at a profit.

The court held that in order for profits on the sale of shares not to be subject to income tax the taxpayer must have a dominant purpose of maximizing dividend income, and that any selling of shares must be purely incidental to this objective. Tod's share transactions were held not to be purely incidental to the objective of maximising dividend income and the proceeds were subject to income tax.

In Nussbaum's case, which was decided in the then Appellate Division in 1996, Nussbaum was a retired school teacher who had inherited a substantial share portfolio. He testified that he always acquired shares for earning dividend income and that he had never bought a share for profitable resale. However, his modus operandi was to sell a share if the dividend yield had fallen to unacceptable levels. Since a fall in the dividend yield was usually caused by an increase in the price of a share, Nussbaum generally made profits. The court found that even though he had the primary purpose of earning dividend income, there was a secondary purpose of dealing in shares that rendered profits subject to income tax.

Market conditions aside, it is therefore wisest from a tax perspective to wait a minimum of three years before selling shares.

Tax avoidance versus tax evasion

Finally, you have the right to avoid paying tax and there is nothing wrong in taking advantage of the tax rules as long as you do not break any of them. This is easier said than done because of the complexity of the South African tax laws, which makes it extremely difficult for the lay person to accurately identify the difference between tax and tax evasion. So it is best to get good professional advice.

Tax avoidance is also known as "tax planning" and is a minimising by legal means of the amount of tax you have to pay. On the other hand, tax evasion is minimising your tax obligations illegally by giving false information to the tax department. Your objective should be to keep a clean slate when it comes to tax. By following the straight and narrow and not unnecessarily drawing attention to oneself will ensure a life relatively free of complications in an era where complications tend to the norm rather than the exception.

Fundamental and technical analysis

How do you know which shares to buy? Enhance your knowledge of the stock market through research on the stock market through regular reading of financial literature, attending investment courses and seeking qualified experts' advice. This will enable you to make educated decisions on which shares to invest in. Any investor in the stock exchange is faced with three important considerations:

  • Which shares should I buy?
  • When should I buy such shares?
  • When should I sell such shares?

When answering these questions it is important to draw a distinction between the two main approaches to share market analysis, namely:

  • Fundamental analysis - Fundamental analysis is concerned primarily with analysing the future profitability of the company in whose shares we are considering investing in. In short, fundamental analysis addresses the question of "which shares to buy". In order to answer this question, fundamental analysts take into account a vast array of factors such as economic variables, political factors, labour relations, management expertise, technological advancements, etc.
  • Technical analysis - Technical analysis is concerned with the use of graphs and statistical techniques to study historical price and volume patterns in order to predict the future course of share prices. It serves to determine "when to buy or to sell" shares.

Choosing your first shares

When choosing one's first shares keep the following points in mind:

  • Always choose quality - Rather buy shares in large stable, well-established and well managed companies such as Anglo American, Firstrand, etc. Shares in these companies are called "Blue Chip Shares". People who are attracted to this class of shares are usually security conscious investors seeking a sound medium- to long-term investment as a hedge against inflation. They offer a reasonable, steady growth in the market value of the shares over a medium- to long-term, coupled with a steady growth in investment income in respect of increasing dividend declarations made out of increasing profits. Blue chip companies are also generally more well-known and have a reputation for honest and fair business practices (e.g. in relation to tax authorities, labour disputes, lawsuits etc.). Investing in these shares will substantially reduce your risk.

In contrast, "Speculative shares" are shares in companies with a scant track record. The price of such shares can soar or plummet, literally overnight. They have a high potential for return coupled with a high degree of potential loss. Investors who go for speculative shares are normally out for a 'fast buck' like punters who are prepared to take a risk in the hope of winning. More often than not their investment decisions are based on rumours, which could result in a substantial profit or an enormous loss. A sound company should show consistent growth and dividend distributions over the previous three years, and have a record of uninterrupted dividends over the previous five years.

  • Always choose shares which are tradeable - Shares are usually highly liquid, particularly ordinary shares in blue chip companies which can be traded within a matter of hours. The problem with highly liquid investments is the natural temptation to convert them to cash just when they start to do well. In many cases, the proceeds are misappropriated into some or other costly fantasy, such as an overseas holiday or a new car. Such action obviously has a major detrimental effect on one's long term planning. Shares should be held with a definite view to the long term and should not be sold in the short-term purely to release cash.
  • Always choose your timing carefully - Once you have identified the shares you wish to buy, it is vital that you never buy shares on a whim or merely follow the crowd. As a rule the highest returns are earned through the careful accumulation of shares when most people are too scared to buy. Take the time to analyse price movements in the market by using technical analysis in order to gain some insight as to when to buy.

Things you should never do

These rules should always be followed:

  • Never buy shares on "hot tips" alone - only buy after you have thoroughly researched the share and would have bought it even without the tip.
  • Always justify your purchases by backing them up with exact reasons - write down your reasons so you can examine them with hindsight later.
  • Never be greedy!
  • Do not let your emotions rule - do not get excited when you make money or despondent when you lose money.
  • Never marry your shares - get too attached to your "winning" shares or shun your "losers".
  • Never buy shares with borrowed money.

Financial literacy

You are best qualified to look after your own money!

Many people find investing in unit trusts very attractive in that they require no thought. Once your stop-order is set up you can more or less forget about the whole problem. In America this type of service is called a "no-brainer". The philosophy is similar to that suggested by the enforced saving of endowment policies. You are paying someone else to think for you. Perhaps it is time to identify a rule of life, one that you actually know, but perhaps have never put into words: "You can only make money from things that you understand well and where you are actively involved". Consider your profession. You make money there because you really understand the work and you are actively involved in it every day. In the same way, you will make money from the share market once you understand it and when you become involved - not before. Could you achieve success in your career by appointing someone else to do your work while you yourself remained uninvolved and ignorant? There is no "free lunch" in this life. You cannot expect to make money from something when you are both passive and ignorant of it.

Invest first in your education, then in the share market.

Understandably, many investors want to be involved in the process of investing directly in shares and learning more about the share market. But it does take time and many hours of study before you will be able to manage your own portfolio. The simple message from this tutorial is that you cannot expect to make money from your investments unless you are prepared to take personal responsibility for your own financial affairs.

This implies that:

  • You need to educate yourself in the art of investment. Get as good an education in investment as possible by studying investment principles such as fundamental and technical analysis, as well as portfolio risk management and reading as much financial articles as possible. Apart from one's health, the best investment anyone can make is an investment in oneself. Investing on one share market is very much the same as investing in any other share market in the world as the same investment principles apply. Investment education is an investment that is totally transportable and can never be taken away.
  • It implies that one obtains access to the information necessary to follow what is happening on a day-to-day basis. However, the developments in software programming, as well as the increased ability to communicate with the share market, have made this much easier for the private investor.
  • It further implies that you need to understand the fundamental principles of financial statements and to make those financial figures meaningful to yourself. Literacy is the ability to read and understand words. But what is meant by financial literacy? It is the ability to read the financial reports of a business and know with confidence what the numbers are telling you, where they come from and what they might hide. It is also about knowing how numbers may be manipulated to tell a story that differs from the financial reality of the business.

PSG Securities Ltd website registration process

  1. Please register by visiting the PSG website here.
  2. On the PSG Securities Ltd homepage, click on "LOGIN" button and then select the "REGISTER" button to the right of the login area in the top right-hand corner of the page.
  3. On the registration page, find the section called FREE TRIAL.
  4. In the next section called Personal Information - enter your personal details and select a Username and Password (It is important to please write this down for future reference!). Enter your email address, select SA citizenship and enter your ID number. Click Next.
  5. You will need to open a trading account (BDA account) with PSG Securities Ltd but you do not have to start trading as yet. You may transfer some funds into your trading account to cover the monthly R 40 per month admin fee. For this you will have access to all the trading facilities, the research, watch lists, as well as the trading simulator.

The equities trading simulator

  1. To access the Trading Simulator, you must first login with your Username and Password.
  2. On the landing page, find select the SIM account by clicking on the drop-down arrow key from the "Select Account" section in the top-right hand part of the screen.
  3. Click on the blue "Portfolio" button on the far left side of the screen
  4. To start trading, select the orange "New Order" button.
  5. Enter Share Code of the share you would like to trade.
  6. Select the "Buy" option.
  7. Enter the number of shares or Quantity that you would like to buy.
  8. Enter the Price at which you would like to buy.
  9. Click Submit button.

Subscribe to the Wen Professional Plus charting software

At a later stage you may consider acquiring some charting software which helps you to track the markets, as well as help you to time your buy and sell transactions better.

  1. The Wen Professional Plus charting software is a FREE program available to order from the PSG Securities Ltd website.
  2. To keep your Wen Professional Plus database up-to-date, you will need to subscribe to the DataShare download service at R 169 per month via debit order.
  3. To order, click on the REGISTER button and then find DATASHARE under EXISTING CLIENT (Assuming that you completed the registration process explained earlier.)

Conclusion

The objective of this tutorial was to lay a foundation and to explain some basic share market concepts. The share selection process is obviously very basic at this stage but the aim is to give you, the novice, a quick overview of the process. As you gain more knowledge with regards to fundamental and technical analysis, you will add stricter criteria to your personal share selection process and over time, hone your abilities even further.

Support

If you have any further queries, please feel free to contact our educational team on shaunvdb@psg.co.za or call 0860 774 774.

Thank you for your support and happy trading!

Copyright © PSG Konsult Ltd (1998-2017), All Rights Reserved. FAIS affiliates of the PSG Konsult Group are authorised financial services providers.