Choosing shares to buy

Picking which shares to buy

Choosing shares to buy and sell requires a lot of time, research and analysis. You are also competing with professionals who have more experience and have access to additional information.

However, if you're willing to put in the time and keep an eye on the market and economy, shares have the potential to grow your wealth over time. Here are some tips to get you started.

Understand the economy and financial environment

As a starting point, it's important to educate yourself about how economic and market changes can impact a company's earnings.

The more reliable the information you have, the better your decisions will be. Here are some places where you can get information about market changes:

  • The Reserve Bank of Australia's quarterly Statement on Monetary Policy for commentary on the Australian economy
  • The business section of reputable websites, magazines and newspapers for new economic information
  • The research department of banks and stockbrokers for forecasts about economic conditions

Topics to keep up-to-date with include:

  • The Australian economy
  • Interest rates
  • Government policy
  • Exchange rates
  • Investor sentiment
  • Overseas economies and markets relevant to the business

You should also focus on industry specific or even regional influences that might impact a company's profits.

Finding shares to buy

Blue chip companies

If you are going to choose your own shares, a good place to start is with the S&P/ASX 50, a list of Australia's top 50 companies, commonly known as 'blue chip' companies.

Blue chip companies tend to be long established, stable companies that suit investors looking for steady returns with less risk.

Speculative companies

Companies that don't have a long history and are not in the top 100 companies in Australia are known as 'speculative' companies. While there may be potential for a large return, be aware that the opposite is also true and you could potentially suffer large losses.

Speculative shares are most suited to experienced investors who are prepared to risk their initial capital in the hope of higher returns.

Buy what you know

Smart tip

You could consider participating in an employee share scheme if the company you work for has one, and you understand how it operates.

Start with an industry or business you understand. You have a much better chance of recognising if a company is weak or strong if the industry is familiar to you. Check out the Australian Securities Exchange (ASX) list of companies or the Chi-X website for a breakdown of industry sectors.

Once you have a list of companies it pays to consider the competition that a company faces and how it compares to others in the sector.

You should find out:

  • What is the company's position in the market?
  • Are the goods and services it provides likely to be in demand in years to come?
  • Are there opportunities for the company to grow in the future?

You can get more tips from our section comparing companies in the same industry.

Capital growth or income?

Work out what you want from your shares. Do you need regular income or do you just want capital growth?

If earning a regular income is important, then you may want to look at companies that have a track record of paying high dividends, which tend to be the larger companies on the ASX.

Smaller companies are often focused on growth, so they are more likely to reinvest their profits in the business, rather than paying dividends to their shareholders.

Market sectors

Each sector of the market has its own benefits and risks. For example as a general rule:

  • Financial sector - Banks and other financial institutions usually offer steady income through high dividends.
  • Resources sector - Mining companies offer potential for high capital growth but tend not to provide large dividends. This industry can be highly cyclical, which means it does well when the international economy is healthy, but badly when it is suffering.
  • Consumer sector - Retailers offer medium-sized dividends. This sector tends to move up and down with the Australian economy.

Researching companies

The value of your investment depends on the health of the business so it's important to research and compare before you invest.

Annual reports

One of the best sources of information is a company's annual report. This contains many important things you need to know about a company, including:

  • Core business activities
  • Future prospects
  • Whether the company is making a profit or loss
  • Company strategy

Annual reports can overwhelm you with information so we've identified several useful things you should look out for. See annual reports for more details.

Company alerts

For more up-to-date information, set up a free Company Alert and we'll email you every time a company lodges information with ASIC, including takeovers, buybacks and floats.

You can also visit the ASX website and check the 'Prices and Announcements' section, which lists documents received by the ASX.

The business section of the newspaper will also keep you informed.

Prospectuses

If a company is issuing shares for the first time, another useful source of information is its prospectus. To find out more, see prospectuses.

Research reports

Share brokers will often give you access to research reports for various companies.

Comparing companies in the same industry

Comparing a company to its competitors is one way of assessing its value. Companies release a lot of key information that will give you some idea of whether their share price is under or overvalued.

Bear in mind that these are very simple comparison tools. Professional investors will often take months to determine whether a share is worth buying. They are trying to predict how much profit a company will make in the years ahead. No one measure will give you the information you need, so always use a range of sources.

Here are some comparison tools that you could start with:

  • Earnings per share (EPS): EPS is the portion of a company's profit allocated to each share. The higher the EPS, the more a share is potentially worth. Companies publish their earnings per share, so you can find this information on their website, in their annual report or on the ASX website.
  • Price earnings ratios (P/E): This can be a good way of working out whether the price of a share is over or undervalued compared to its competitors. In general, the lower the ratio the better. But a low ratio is not always a good thing. It could mean that the market expects earnings to be lower in the future. To work out a P/E ratio, divide the current price of the share by the earnings per share.
  • Dividend yield (%): Dividends are paid from profits and can be a good reflection of how the company is performing. But a high yield is not necessarily a good thing, especially if the dividends come from borrowings. To work out the yield, divide the dividend per share by the share price.

Case study: Barry decides which shares to buy

man-with-paperBarry wants to invest in shares so he uses the above comparison tools to help him decide between two companies in the same industry.

Choosing which shares to buy and tracking their performance gives you a sense of control and can be very gratifying. Just remember to do your research and keep up to date with your companies' performances.

Diversify your portfolio

Shares are considered growth investments and can give you strong returns over time; however higher potential returns usually come with higher risks. Before you invest in shares consider what would happen if you lose some or all of the money you've invested.

See risk and return for more information about identifying and managing risk.

One of the best ways to protect your portfolio is to diversify - that is, to spread your investment between different industries. Investing in, say, eight companies in different industry sectors is less risky than just one or two.

That way, you can take advantage of each company's strengths and are better protected if one industry has a bad year. Also, if one company goes belly up you will only lose a part of your investment, not your whole portfolio.

Building a portfolio of shares can be rewarding but you need to have the skills and experience to make it worthwhile. If you'd rather leave the decisions to someone else, there are other ways to invest in shares. You might consider investing in ETFs or a managed fund for example.


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Last updated: 18 Aug 2015