Mastering Share Market Charting: Basic

Step by step:

Or how to grow wealthy with the minimum of effort

By Richard Cluver

Financial security means never again having to worry about how you are going to pay the household bills at the end of the month and never again having to worry about the financial implications of a family crisis.

It also offers you the freedom to take a break whenever you please; to travel or be able to implement projects you have dreamed of all of your life. But most of it buys you peace of mind.

For most people, however, the concept of such wealth is a seemingly impossible dream. Judging by the latest official statistics, the average South African is totally enslaved by debt, spending up to 82.3 percent of their disposable income on paying off debt. Furthermore nearly half of credit-active consumers are three or more months behind on debt repayments.

Clearly then, we as a nation need to make it an urgent national priority to rid ourselves of debt. If you are one of the fortunate few who is debt-free and actively desiring to grow extremely wealthy through a systematic investment plan, then read on. I promise you it will not require more than ten minutes of your time each day.

If, however you are one of the majority of South Africans who are drowning in debt, then before you can even begin to dream of building vast wealth via investment, you need to develop an effective plan that will render you debt-free in the shortest possible time. So read on to the end of this lecture and then tick the “I’m drowning” box and we will start with an in-depth look at the most effective means people have of dealing with debt.

For the happy few who have already realised that debt is the modern version of slavery and who are determined to be free, we are confident that the most effective means of achieving this objective is via stock exchange investment: by regularly saving a portion of your monthly income and dedicating it towards the step-by-step acquisition of a Blue Chip share portfolio.

To prove this view to you, let us begin by considering the stock market options of the beginner investor, noting that over the past ten years the average growth rate of Blue Chip shares was 24.6% a year. On average, furthermore such shares have yielded a dividend return of 3.4% making for a total return of 28% which, since dividends are taxed at just 15% compared with the 40% marginal tax rate for South African individuals, is the equivalent of a return of 45.8% on a normally-taxed money market investment.

So let’s do the maths. Let us assume that you are a young person just starting out in your first job with something like a 40-year working expectancy ahead of you and able, furthermore, to invest R50 000 in such an investment portfolio. Let’s also assume that, other than re-investing the annual dividend income off that R50 000, you never save another cent. Given these strictures you might be very surprised to learn that you could expect to have at retirement an investment portfolio worth something of the order of R100-million….and furthermore that this sum would provide you with a monthly income of R283 000.

From this it is clear that long before your normal retirement age, you would have reached a level of wealth that would have opened up a multitude of life options of which the very least might have been early retirement.

Such incredible wealth numbers are hard to believe given the common—dare I say cynical—experience of people who have tried to grow their savings using instruments such as unit trusts and life assurance policies which are the normal resource of ordinary folk.

The sombre fact is that unit trusts have on average been dismal investment performers. Whereas over the past ten years the average Blue Chip share has risen by compound 24.6% annually, the average gain achieved by all the unit trusts that have been in business for ten or more years has been a pitiful 7.7% annually. The graph on the right illustrates the difference between the two averages on a percentage annual change basis over the past decade.

Just why unit trusts perform so badly for the people who invest in them can be partially explained by the fact that they are customarily bought through investment advisers who collect commissions on each transaction. Furthermore the companies that manage unit trusts also collect management fees in addition to the normal transactional taxes and brokerage associated with the buying of the underlying securities.

So what would be the result for our young investor if he were to have put his initial R50 000 into an average unit trust and held it unchanged for the next 40 years? Well, again assuming he had re-invested all his dividend income, he would have achieved an effective compound growth rate of 11.1% and over the next 40 years this would have grown his original capital to a total of R3.37-million.

Can it really be possible that two different investments can yield such a dramatically different outcome: on one hand R100-million and on the other just R3.37-million? Well what readers need to take to heart is that the real secret of growing great wealth is the power of compound interest and that is why just a small difference in the returns you are able to achieve when you invest your hard-earned savings will in the end make a dramatic difference to whether you end your days disgustingly wealthy or in genteel poverty.

Decision Time: Just tick the boxes!

□ I would like to be “disgustingly wealthy”

□ I am prepared to make some sacrifices in order to be able to save ten percent of my monthly income in order to achieve it

□ I am prepared to spend ten minutes a day learning how, and thereafter ten minutes a week making sure I am remaining on track

Lecture Two

“I want in now…the mindset that has enslaved the world.

Everybody understands compound interest. After all we all learned about it in primary school arithmetic………..or did we?

Do readers really comprehend the dramatic power of compounding and how they can choose to either harness it to their personal benefit or, as the vast majority actually are, be enslaved by it? To put the subject into perspective we can do worse than turn to Albert Einstein, the father of relativity and nuclear fission who, when asked to name mankind’s greatest invention is reported to have answered: “Compound interest; it is the most powerful force in the universe.”

Used to its best advantage, compound interest has the power to make billionaires of the lowliest of men and to effectively enslave the great majority who choose to borrow money to fund the perceived necessities of life.

To illustrate the point, if you are an average middle-income South African earning around R200 000 a year and you are prepared to save half of your income each year and invest it compounding at a very modest 10 percent a year, you will achieve a million Rands in under six years; enough to pay cash for your first suburban house.

If, instead, assuming again that you earn R200 000 a year, and that on the day you first start work you manage to secure a R1-million home loan which you elect to repay at an even lower compound interest rate of just 8 percent, you will need to pay a monthly instalment of R8 333 – that is half your pre-tax salary — and you will have to keep it up for the next 50 years.

Just to rub the salt a little deeper into the wound, on your original loan of R1-million you will actually repay the bank a total of R5-million.

So the first option of saving just one fifth of your income offers you the promise of early freedom while the latter commits you to paying most of your after-tax salary just to pay off the loan. The latter can only be described as bondage…. just another word for slavery. And for what? R1-million even in these times of depressed property prices will only buy you a very modest home in a working-man’s district. So the choice is yours; freedom at small cost in just nine years or a lifetime of bondage!

Now it is time to recognise that our society has been seduced by a wicked illusion. The Hollywood dream of the young man who claims his just reward for the years of effort in studying for a university degree: a well-paid job, a home with a picket fence and marriage to the sweetheart who has patiently waited for him through their student years; collectively these are really a trap for the unwary.

To marry before you have had a chance to save a respectable nest egg might be OK if both are prepared to work and save together. But add in a home and a car and furniture all paid for on credit and you have a classic formula for modern slavery: the perfect mechanism to ensure that society’s brightest and most hard-working young people will be obliged to keep on working day after day for the rest of their lives with the major benefit of their labours actually flowing to the very few who are smart enough to see through the plot and earn for themselves the title of ‘Capitalist’.

And it is but a short step from this point to see why people enslaved by debt can so easily turn revolutionary; why for example throughout the European summer of 2011 there were Greek people marching in every village and town demanding the overthrow of a system which had allowed them for decades to spend money that they had not earned while as a nation they built for themselves a mountain of debt for which they are now demanding that someone else should pay.

And lest we get too smug about this thought, we should also remember that eight out of ten South Africans are in the same boat! So, if I have held your attention so far, it is time to take one of the biggest decisions of your life. Do you, like most people you know, want to be a slave for the rest of your life? Or are you prepared to expend a minimum amount of effort to master the financial system of the modern world? Would you like to walk with me down the road to untold wealth. Would you, like me, like to become a ‘Ten Minute Millionaire’….ten minutes a day. That’s all the time it should take out of a busy modern life…..that an a commitment to diligently save at least a tenth of your monthly income

Decision Time: Just tick the boxes!

□ I want to become a “Ten Minute Millionaire.”

□ I commit myself to urgently clearing any debts I currently have and undertake never again to borrow money.

□ I am prepared to make some sacrifices in order to be able to save ten percent of my monthly income in order to achieve it.

□ I am prepared to spend ten minutes a day learning how to master the financial system of the modern world and thereafter ten minutes a week making sure I am remaining on track.

Lecture Three

Big is not just better; its vital if you really want to grow your wealth

If you are you still with me, you will now be familiar with my comparison between two talented young people who have just started work earning R200 000 a year. The first young person does as everyone else around him does. He raises a million Rand bond to buy into the Hollywood dream of a house with a white picket fence.

He marries his sweetheart, buys a car and a household of furniture, the latter all on hire purchase, and thereafter spends the rest of his working life in debt. Just meeting his bond instalments consumes half of his pre-tax income and his hire purchase commitments consume most of the rest leaving him with practically nothing to feed, clothe and educate his family. While his starting income is above average, in every other respect he is just like the average married South African whose debt commitments consume 82.3 percent of his monthly income.

Now my second young person – the person I intend to become a Ten Minute Millionaire – makes a different choice. He elects not to marry his sweetheart until he has saved at least a million Rand. He does this by every month saving the same amount as our first young man is paying the bank in bond instalments The problem is, if he uses the normal savings bank approach, he and his sweetheart are in for a very long wait because the savings bank approach paying at best some ten percent is really not the best way to go.

Now it is time to recognise that while the bond repayment example I have offered is a close approximation of what the average person is currently paying, the example of a person saving a fifth of his income and investing it at a compound annual rate of ten percent grossly understates what he could achieve.

Better than using a bank savings account to achieve his long-term investment plans, unit trusts offer ordinary folk an easy means of participating in the growth potential of stock-exchange-listed companies. Collectively they on average offer extremely low growth rates, but at least they offer growth while bank savings accounts merely offer the benefit of compound interest . Furthermore, while the dividend income of equity unit trusts is free of income tax, the interest you earn from a savings account is taxed at your marginal rate.

Now, while it is true that the average growth rate of all South Africa’s unit trusts is an extremely low 7.7 percent currently compared with the 24.6 percent achieved by the average Blue Chip share, once you add in an average dividend yield of 3.4 percent, you can see that Mr Average, who saves via an equity-based unit trust, would be growing his money annually by 11.1 percent provided he elects to re-invest all his dividends. Assume again that he elects to save half of his pre-tax income to keep him in line with the payments faced by the man who raised a million Rand mortgage bond. Assume also, that his pay rises each year by ten percent. If all these factors are combined then he could by this means save R1-million in just over five years.

Now of course there are unit trusts that perform better than this average rate; lots of them. The problem for our young investor is how is he to select the best performers from all the rest? Ask the so-called investment advisers – which is a new term for the old-fashioned insurance salesman — and at best you are likely to be offered a list of the best performers of the past few years. At worst you will be offered the units that pay the advisor the highest commission. The problem, however, is that even if you choose those with the best immediate past track records, there are very few unit trusts which have consistently year after year delivered above average growth rates.

So what is the average investor to do? Well of course you might seek to emulate the practice of many pension fund trustees who elect to spread their funds over several different funds that have in the past offered above average rates of growth and, whenever one of these funds falters in its growth rate for more than three months, simply switch into another high-growth fund.

The problem with this approach, however, is that while pension funds are not subject to taxation when their assets are traded back and forth, when an individual investor decides to switch from one unit trust to another, he becomes liable for capital gains tax on any increase in value that has occurred since he bought into the fund. And if he has held a particular fund for less than three years, his entire gain will be taxed as if it was earned income in his hands. Furthermore, while some unit trust management companies allow the investor to switch between the funds within their stable without attracting sales commissions and management fees, the investor enjoys no such freedom from transactional costs when he elects to switch between different unit trust management companies.

So you can see that it is not very practical to switch between unit trusts in order to try and keep your money exclusively in the top-performers. There is, however, a variant on the unit trusts that does not suffer from the blight of management fees and commissions and, furthermore, has proved itself both here and abroad, to often offer far higher growth rates than the commercially-managed unit trusts. Known as tracker funds which seek to replicate the performance of various share market indices, they do this automatically without the intervention of portfolio managers and in a future lecture I will examine their performance in some detail.

Now, while it is obvious that one should always try to invest in funds that offer the highest possible rates of capital growth, the average investor appears not to understand how dramatically relatively small differences in growth rates can affect the ultimate value of their investments.

To illustrate the importance of seeking to invest your money at the highest possible compound annual average growth rate, let us take the example of the average growth rate of Blue Chip shares listed on the Johannesburg Stock Exchange; 24.6 percent plus an average dividend of 3.4 percent giving us a Total Return of 28 percent. Guess what; in sharp contrast with my example of the young person who elects to save his money at the 7.7 percent average growth rate achieved in recent years by the unit trust industry together with their average dividend yield of 3.4 percent and consequently manages to save R1-million in just over five years, the young person who instead elects to invest in an average Blue Chip share at their average growth rate of 24.6 percent plus the same dividend average of 3.4 percent, would be able to save R1-million in just over four years!

Significant though this difference is, it does little to illustrate the real impact of rate differences because the other vital ingredient in the compound interest recipe is time. Simply stated, the longer you hold money at compound interest, the more rapidly it grows. To illustrate this point, let us calculate what would happen to our two young investors if they each continued with their chosen investment vehicles for an extended period.

So we have two young investors on a starting salary of R200 000 a year who both elect to save half of their pre-tax income. Assuming that they receive a ten percent pay increase every year for the next 30 years, the investor who chooses the unit trust route at an average growth rate of 7.7 percent plus re-invested dividends of 3.4 percent will see his investment grow to R61.3-million after 30 years.

In contrast, the young investor who chooses to put his money into Blue Chip shares which have on average over the past five years grown at 24.6 percent together with an average dividend yield of 3.4 percent making a Total Return of 28 percent, will see his nest egg grow to an amazing R1.16-billion.

So the effect of time and a two and a half times greater growth rate would be to see our second young investor’s capital growing nineteen times bigger.

Decision Time: Just tick the boxes!

□ I have committed myself to becoming a “Ten Minute Millionaire.”

□ I have committed myself to urgently clearing any debts I currently have and undertaken never again to borrow money.

□ I reaffirm my preparedness to make sacrifices in order to be able to save ten percent of my monthly income.

□ I reaffirm my preparedness to spend at least ten minutes a day learning how to master the financial system of the modern world and thereafter ten minutes a week making sure I always remain on track.

Lecture four

Understanding compound interest and why time is vital

To understand why a rate of compounding is so vital to the exercise of growing your personal wealth, you need to get your mind around what actually happens when money is subject to compound interest. I will start by offering you a graph of what has happened to the value of the average Blue Chip share on the JSE over the past 26 years:

Notice the upward curvature that occurs! It is typical of every long-term compound interest graph and it explains why so many investors become deterred in the early stages. Notice that for the first 16 years the graph appears nearly horizontal while the last few years it is nearly vertical.

So let us for a moment consider the numbers. In the panel below I have calculated what happens when 100 is compounded at ten percent. Note in the column on the right how the actual return increases exponentially year after year.

So, the increase between year 2 and 3 is a mere 0.1 whereas between years 18 and 19 it is 0.46 or 4.6 times greater. If you extended the calculation to 50 years the increase would be 88.2 times and after 100 years it would be 9 412 times greater.

Furthermore, as I have explained previously both the time period and the rate of compounding are critical, so instead of compounding at just 10 percent, let us run the calculation using the 28 percent rate of growth of South African Blue Chip shares with dividend re-investment:

Now we see that the actual increase between years 2 and 3 is 2.2 or 22 times greater than in our first example. Furthermore the increase between years 18 and 19 is 113.98 which is 51.8 times greater than between years 2 and 3. Furthermore, if you continued the exercise for 100 years the difference between years 2 and 3 and years 99 to 100 is a massive 1 995-million.

The curvature that is evident in my first graph can be eliminated by plotting our number series on a logarithmic scale. That is a scale of measurement that uses the logarithm of a physical quantity instead of the quantity itself. Thus in the example on the right I have so plotted the ShareFinder Blue Chip Index over the past decade during which, up until the time of writing, it increased by 25.62 percent annually and paid an average dividend of 3.4 percent giving investors an amazing 29.02 percent Total Return. Here the red trend line traces out that compounding rate and offers investors a really useful buying guide. Simply stated, if the index is above the red line the market is expensive and below it cheap. More about this later.

Meanwhile, it is time to start taking stock of your own investment performance up until now. So this is when, if you tick the last box in my “Decision Time” list you will be able to download the ShareFinder Portfolio Analyser, a simple on-line tool that will enable you to see a graphic representation of your personal investment efforts:

Decision Time: Just tick the boxes!

□ I have committed myself to becoming a “Ten Minute Millionaire.”

□ I have cleared my debts and undertaken never again to borrow money.

□ I have identified the sacrifices I need to make in order to be able to save ten percent of my monthly income and I have begun saving.

□ I have identified the savings bank that currently offers me the highest possible interest rate and I have placed my savings in it.

□ I have studied the compound interest example in this lecture and now fully understand why both time and the highest possible investment growth rate are the two factors that can make or break my plan to becoming a “Ten Minute Millionaire.”

□ I want to download the ShareFinder Portfolio Analyser, a simple on-line tool that will enable me to see a graphic representation of my personal investment efforts to date.

Lecture five

“Its not how much you earn but what you choose to do with your earnings that determines who ends up rich”

So, if you have followed me until now you will have taken to heart the fact that for the magic of compounding to really go to work for you, you need both an extended period of time and the highest available interest rate.

And of course Mr Average Man usually fails on both counts. Conventionally he uses unit trusts, a pension fund or an insurance policy as his principal vehicle of saving and, sadly, none of these normally deliver high rates of growth. Not surprisingly then, when viewing retrospectively what they have achieved during their first few years of saving and investing, the average person becomes discouraged by a pathetic growth rate.

Against the 29.02 percent Total Return offered by the average Blue Chip share over the decade ended December 2011, unit trusts have failed miserably in their mission to provide the public with an easy to use means of investing in the share market. Over the same period the average unit trust has delivered a mere 7.86 percent growth plus dividends totalling 3.4 percent or a Total Return of 11.26. So, if you plan to use unit trusts, at least in the beginning of a savings campaign because of their ease of use, you need to understand why this Total Return average is so low and how to select better-performing funds.

Various schools of thought exist as to why the average fund performs so badly. Internationally there is a substantial body of research which argues that the average portfolio manager is quite unable to beat the standard market indices. Another widely-held view is that the majority of financial institutions that manage unit trusts, have treated them as cash cows; milking them for all they are worth with a barrage of management fees and sales commissions which have so burdened the funds that they are quite unable to perform.

Whatever the reason, their failure to deliver has led to the development of a new type of fund known as an index tracker. Simply explained, the people who operate these funds do not need any specialist training nor any great investment insight. All that they are required to do is ensure that their tracker funds precisely replicate the constituents of the various share market indices. Officially known as Exchange Traded Funds or, EFTs for short, these funds have a further advantage that they trade daily on stock exchanges during normal trading hours and can therefore be bought and sold just like regular shares on the stock exchange. So, instead of purchasing one share on the stock market you can purchase the performance of the top 40 shares on the JSE with the purchase of a single ETF unit. Most ETFs track an index such as the FTSE/JSE Top 40 Index. For example, the Satrix 40 tracks the FTSE/JSE Top 40 Index.

ETFs are similar to unit trusts inasmuch as you are invested in a basket of shares (a group of shares such as the Top 40 companies on the JSE) in the same way as a unit trust does. However whereas most unit trust only trade once a day, ETFs trade in real time on the stock exchange. In other words they fluctuate in value minute by minute just like ordinary shares and the price is available to the public throughout the day.

For the South African investor, the best of these are the Satrix series of funds which are administered by the Johannesburg Stock Exchange. Currently there are seven different Satrix funds; the Satrix 40, the Findi, the Indi, the Resi, the Swix, the Divi and the Rafi representing in turn the Top40 Index, the Financial Index, the Industrial Index, the Resources Index and so on.

The Satrix SWIX Top 40 endeavours to replicate the performance of the JSE SWIX Top 40 index. This, shareholder-weighted Top 40 index, makes use of the share register of the top forty companies to reduce the constituent weights for foreign shareholders in these stocks. In addition, the SWIX Top 40 is adjusted for cross-holdings and strategic holdings. The impact is to reduce the weightings of mainly resource and dual-listed stocks in the Top 40 index by approximately half.
The asset manager of the Satrix SWIX Top 40 accurately replicates the FTSE/JSE SWIX Top 40 index, by holding the exact weighting and number of shares that constitute this index. Any dividends that are paid by the top forty companies are paid out to Satrix SWIX Top 40 shareholders payable on a quarterly basis. In this way the holders of Satrix SWIX top 40 securities replicate the total performance (capital plus dividend yield) of the top 40 companies listed on the JSE.

The Satrix Rafi weights its underlying constituents using four fundamental factors, rather than pure market capitalisation. These are dividends, cash flow, sales and book value. Secondly, the RAFI 40 tracks the total return version of the FTSE/JSE RAFI 40 index, measuring the total return of the underlying index by combining the capital performance plus the reinvestment of income of the constituent companies in the index. All dividends received are immediately reinvested on behalf of investors.

Collectively these funds have shown themselves to be far superior to the average commercially-offered unit trusts and are very worthy of consideration by small investors who do not want to trouble themselves with the problems of choosing individual blue chip shares. There is, however, at this stage a small problem inasmuch as the Satrix series have not been around for long enough to warrant really meaningful comparison with the most recent and best performing of these only becoming available to the public in September 2009.

Judging, however, from my comparison graphs above, the Satrix Divi and the Satrix Rafi appear most likely to be your best options as a savings vehicle. When we compare their performance with the average Blue Chip share, however, neither of the Satrix funds has done all that well as illustrated by my second graph composite which illustrates that since the Satrix Divi and Rafi were released in September 2009 they have grown by 35 and 38 percent compared with the average Blue Chip share which has grown by 51 percent.

So, assuming once again our example of a young person with a 40-year working life ahead of him and R50 000 to invest, we should note that, allowing once again a 3.5% average dividend yield being ploughed back as the money is earned year by year, we might calculate that were these percentages to remain constant until our investor reached retirement age, the Blue Chip investor would be worth R95.5-million, the investor in the Rafi would be worth R33.9-million and the investor in the Divi would be worth R22.5-million.

It goes without saying that Blue Chip shares win hands down! So, if you would like to download a free trial version of the ShareFinder Cloud computer programme which will automatically select a portfolio of Blue Chips for you, assist you to open a stockbrokers’ account and begin simulation trading, just click the last box on my “Decision Time” list.

Decision Time: Just tick the boxes!

□ I am putting aside a tenth of my income each month. I have been saving in a savings bank that currently offers me the highest possible interest rate and I have placed my savings in it.

□ I understand compound interest and recognise that time and the highest possible investment growth rate are the sole factors that can make me a “Ten Minute Millionaire.”

□ Now I also understand that at the very least I should invest my savings in an exchange traded fund. To that end I have downloaded the free ShareFinder Portfolio Analyser, a simple on-line tool that will enable me to see a graphic representation of my personal investment efforts to date.

□ I now realise that if I really want to see my money grow I need to understand how to identify a blue chip share. Please give me a trial version of the ShareFinder Cloud computer programme that can do all my share selections automatically.

Lecture six

So how do you identify a Blue Chip Share?

Over the past few lectures I have illustrated to readers that the surest and easiest way to grow very wealthy, is to save the maximum you can every month and with the proceeds embark on a systematic Blue Chip share buying campaign. Now you need to learn how to identify a Blue Chip share and understand how and when to buy them.

At the end of the last lecture I offered you an opportunity to download and test the ShareFinder Cloud computer programme that automatically analyses your personal investment profile and builds you a suitable risk-adjusted portfolio as well as assisting you open a stockbrokers account and begin simulated share market trading. If you have not yet done so, might I suggest you go back to the end of the previous lecture and tick the appropriate box. Then work your way through this lecture which will help you to clearly understand the process of Blue Chip share selection.

Over the past decade, Blue Chips have delivered an amazing average annual price growth rate of 29.02 percent.

The graph above illustrates the value performance of the ShareFinder Blue Chip Index from 2002 to 2012 which grew by an annual average of 22.8 percent and on average delivered a dividend yield of 3.4 percent making a Total Return of 26.2 percent.

Furthermore, if you select your Blue Chips carefully, it is possible to achieve an even higher Total Return. And, as opposed to the usually random approach of simply selecting last year’s best-performing unit trust which you hope will deliver superior market performance, in the case of Blue Chip shares it is comparatively easy to measure the long-term performance of their balance sheet statistics, noting that there is an absolute correlation between the sustained profits performance of a company and the value of its shares. It is also comparatively easy to sort such companies into risk versus growth categories.

I define a Blue Chip as a share of a company that, among a series of qualities, has paid constantly-rising dividends over at least a decade. A little bit of homework in the library using back copies of the Stock Exchange Handbook will help you find them. Alternatively, you can subscribe to my ShareFinder Cloud computer programme which for just R1 400 a year will provide you with a Quality List of all the top performers. Indeed, at the touch of a button it will create a portfolio tailor-made to your personal needs and, furthermore, once you have bought its selected shares, it will watch over your portfolio instantly identifying any shares that are beginning to run out of steam and suggesting a range of quality replacements.

At the time of writing there were some 71 companies listed on the Johannesburg Stock Exchange that have delivered consistently-rising earnings over the past decade. In the table on the right, I have listed them all.

I have, furthermore, grouped the shares in a descending series of rankings which, in a nutshell, represent ever-increasing risk as one moves down through the categories.

Understanding how to sort stock-exchange listed companies into quality categories is important if you want to minimise the risk of price volatility.

In my book “The Philosophy of Wealth” ISBN 0 9583067 6 1 I devoted some 112 pages towards explaining a systematic series of tests of fundamental balance sheet statistics which would collectively lead one to isolating various categories of investment grade companies. While I have no intention at this stage of re-iterating all that detail, The Philosophy of Wealth should be seen as an essential companion to this book as well as recommended reading for all serious students of long-term investment techniques.

In that work I showed how all “Investment Grade” shares might be lumped together under six distinct categories of risk and reward. I defined these as follows:

The Grand Old Favourites

This is the safest category of all for long-term investment. Within it are found the “big cap companies” with, in South Africa, a market capitalisation exceeding R10-billion, which have consistently delivered higher than average earnings, dividend and price growth rates over extended periods of time. This is a category which by definition includes shares in companies beloved of people seeking to set up widows and orphans trust funds. Collectively the group enjoys lower price volatility than long-dated Government bonds and I accordingly use their mean volatility rate as the benchmark against which the volatility of all investment grade shares is rated in order to, within the ShareFinder computer analysis system, create risk ratings for every listed company.

Furthermore, these have in addition also experienced higher than average exponential rates of dividend growth which is calculated by comparing the five year compound annual average dividend increase percentage with the compound annual rate of increase for the previous ten years. In cases where the latest dividend growth rate exceeds the five-year rate and the five-year rate exceeds the ten-year rate, such exponential growth performance is invariably rewarded by sharply higher rates of price growth. When the converse occurs, however, and the latest rate falls below that of the five-year rate, the price growth rate can be expected to fall in the short-term. Analysts usually regard these latter events, in companies with such excellent credentials, as an opportunity to buy the shares at a lower than usual price. It should, however, be taken as a warning that problems might lie ahead. Should further growth rate reductions occur, the market will interpret this as a sign that short-term problems are becoming entrenched and there will in all probability be a sharp reduction in the future share price growth rate.

Though in the short to medium-term these Grand Old Favourites often produces lower share price and dividend growth rates than some of the other categories, it is their ability to generate relatively high and consistent earnings and dividend growth rates over very extended periods of time that make them such desired ingredients in long-term portfolios.

Mid-Cap Companies

These are companies with a market capitalisation greater than R1-billion that have also delivered consistently high earnings, dividend and price growth rates over extended periods of time. Like the Grand Old Favourites they normally enjoy both extremely low rates of price volatility and high dividend and share price growth rates. Furthermore, these have in addition also experienced exponential rates of dividend growth which can be seen by comparing the five year compound annual average dividend increase percentage with the compound annual rate of increase for the previous ten years.

Here, it is obviously desirable that the latest dividend increase should exceed the five-year rate. Should the latest increase fall below the five-year average rate of increase, this might offer an opportunity to buy these shares at a lower than usual price. It should, however, be taken as a warning that problems might lie ahead. Should further rate reductions occur, there would in all probability be a sharp reduction in the future share price growth rate.

Tightly-Held Mid-Cap Companies

This category enjoys all the attributes of the Mid-Cap Companies with one exception, that relatively small numbers of the shares are available to ordinary investors. This makes them comparatively hard to obtain and in theory renders them liable to severe price volatility. In practice, however, they are tightly-held precisely because they return such consistently high dividend, earnings and price growth rates that the voting blocks which control them are unlikely to sell. Furthermore, these have in addition also experienced exponential rates of dividend growth which can be seen by comparing the five year compound annual average dividend increase percentage with the compound annual rate of increase for the previous ten years.

Here, once again it is obviously desirable that the latest dividend increase exceeds the five-year. Should it fall below the five-year average rate, this might offer an opportunity to buy these shares at a lower than usual price. It should, however, be taken as a warning that problems might lie ahead. Should further rate reductions occur, there will in all probability be a sharp reduction in the future share price growth rate.

Blue Chips

These are the companies that remain when the above three categories have been stripped out of the list of companies that have consistently delivered rising dividends over at least the previous ten years. As a rule these are also extremely safe investments but they tend to deliver relatively lower total returns than the other three categories. The best of this category usually also experience exponential rates of dividend growth which can be seen by comparing the five-year compound annual average dividend increase percentage with the compound annual rate of increase for the previous ten years. However, in some cases this is not so and this should be taken as a warning that problems might lie ahead. Should further rate reductions occur, there will in all probability be a sharp reduction in the future share price growth rate. Should dividends at any time fail to either equal or exceed those of the previous year, these shares are regarded as having fallen from grace. In my own ShareFinder rating system we did for many years simply dropped such companies from the blue chip category and they did not regain this status until they had again achieved a minimum of ten years of rising dividends. Recently, however, we have changed that approach having noted that in the marketplace such shares tend to recover much more rapidly than that. Accordingly, and provided that earnings per share have not similarly fallen, we nowadays keep such shares in the Blue Chip category.

Here I should note that when such hiccups occur in a company dividend and earnings pattern and they are accordingly relegated to my Fallen From Grace category, it pays to keep a sharp eye on their subsequent price performance for it is normally the case that should their annual figures show any signs of returning to their previous track records, a sharp increase in share prices is the normal result.

Medium-Term Market Leaders

Drawn from a list of companies whose primary fundamental quality is that they have paid constantly rising dividends for a minimum of five but less than ten years, these are a category which have in addition also experienced exponential rates of dividend growth which can be seen by comparing the latest dividend increase percentage with the compound annual rate of increase for the previous five years.

Usually this category of companies will provide the highest share price increases, making them the market darlings for a while. Few, however, have ever managed to maintain these very high growth rates for extended periods. The best of them subsequently end up in the Grand Old Favourites, Mid-Cap or Blue Chip categories if they are able to sustain their exponential dividend growth rates for at least ten years, but usually by this latter stage the dividend growth rate will have slowed to a more measured and sustainable rate. The majority, however, run out of steam and quite often fall from grace. It would accordingly be unwise to weight too many of these into a long-term growth portfolio.

Rising Stars

These are companies whose primary quality is that their dividends have remained unchanged or have risen for a minimum of five years. Here it is importat to note that many of these might have been subject to a dividend growth-rate reversal in the latest year of reporting and this often precedes an actual dividend decline the following year. In such circumstances, such shares will normally experience a sharp share price reduction and will thus be dropped from this category, not to be restored until they have rehabilitated themselves by achieving a minimum of five years of steady or rising dividends.

Maverick Market Leaders

This is a category of companies with very few claims to fundamental quality, which for inexplicable reasons have shown exceptional price growth. I like to display them in descending order of compound annual average share price growth rate and those topping this list will, despite their uncertain credentials, have achieved very high rates of share price growth. Some might in time achieve the fundamentals that will elevate them to the six quality categories. Here, it is worth keeping an eye on those companies in this category which have achieved exponential dividend and earnings growth rates. Often these are cyclic profit companies of good reputation which are enjoying one of their periodic phases of profit growth which will often be reflected by rapid speculative share price gains. Sometimes it will be a sign of improving fundamentals which might in time lead to such companies being elevated in status to one of the higher categories.

Decision Time: Just tick the boxes!

□ I am putting aside a tenth of my income each month and I have been saving in a savings bank that currently offers me the highest possible interest rate.

□ I understand compound interest and recognise that time and the highest possible investment growth rate are the sole factors that can make me a “Ten Minute Millionaire.”

□ I also understand that I can guarantee my future wealth if I continue saving a tenth of my income and, at the very least, investing in an exchange traded fund.

□ However I am not content just to be comfortably-off at the end of my working life. I want to become seriously wealthy and I understand that only through investing in blue chip shares is this possible. I therefore undertake to re-read Lecture Six until I fully understand it, if necessary going to the RCIS website at www.rcis.co.za and ordering Richard Cluver’s three latest books: “Footsteps to Fortune”, “The Philosophy of Wealth” and “Simple Secrets of Stock Exchange Success” in order to fully understand the process of Blue Chip share selection.

□ I have also downloaded a free trial of the ShareFinder Cloud computer programme and am now beginning to understand the Quality List ranking which is the heart of the systematic investment grading process that makes it possible to grow my investment capital as rapidly as possible with the minimum of risk.

Lecture seven

How to pick market-beating shares

Statistics tell us that in addition to their primary residence, over 200 000 South Africans have at least R1-million invested and of those 50 699 “Super Rich” individuals have over R7.29-million. Furthermore, the average Super Rich South African is comparatively young: barely into their middle age judging from the statistics.  So it should be plain that is it possible for quite ordinary people to achieve such sums?

Hopefully I have in previous chapters satisfactorily proved that the most commonly-trod path to great wealth over the past century has been the stock exchange. As proof of this argument I have displayed the graph below of the ShareFinder Blue Chip Index with a trend line linking its lowest point 27 years ago with its current peak value at the time of writing.

At its lowest point in April 1986 it fell to an index value of 2138. It reached a new peak value of 417 576 on August 28 2012. If you care to calculate it you might thus determine that were you to have bought a basket of shares in April 1986 representing the index at that point and held them unchanged until August 2012, a R100 investment then would now be worth R19 531.

That is a compound annual average growth rate of 22.1 percent over the past 26 years. And, of course, had you regularly saved a tenth of your income, accumulating it in a savings account and used the techniques outlined in my books “Footsteps to Fortune”, “The Philosophy of Wealth” and “The Simple Secrets of Stock Exchange Success” to choose the most appropriate moments to buy winning shares, you would have vastly increased that growth rate.

To illustrate this point, had you applied the simple test of selecting only those companies whose shares had achieved the consistently highest dividend growth over the past decade and, furthermore, whose shares were traded in reasonably high volume, then topping that list would have been Capitec Bank which had over the past decade risen in price from 80 cents a share to a 2012 peak of R228.80. That is a remarkable compound annual average growth rate of 72.1 percent which would have taken a R100 investment then to R28 600.

Now it would have been wonderful if you had been able to spot Capitec back then and have risen with it up to the top of a comfortable fortune. But the probability is that you would not have spotted it for the simple reason that there was no practical statistical profit record that could have guided you towards highlighting its performance. So let us be a little more realistic and select a company whose shares have been regularly traded in high volume – at least a million shares a day on average – and which has achieved consistently high dividend growth rates over an extended period.

The ShareFinder Quality List displays company performance statistics in green when they are above average which makes it easy to see in the table extract on the right that over the past decade Shoprite Holdings achieved a superior dividend growth rate of 27.47 percent which, in the most recent five-year period accelerated to 31.23 percent annually. Furthermore, as a consequence of this high dividend growth rate the share price grew over the decade to 2012 at a compound annual average rate of 37.79 percent. Had you ten years before put up a graph of the price performance of the share you would have seen that at that stage it was growing at compound 26.9 percent over the previous decade as illustrated by the green trend line in the graph below

Now, let us assume that ten years previously you were earning R200 000 a year and through diligent saving over the past few years had managed to save a lump sum of R50 000. Now you commit yourself to saving a minimum of a tenth of your gross income i.e. R20 000 a year. Furthermore, let us assume that you were a hard worker who was rewarded with annual pay increases of 10 percent which allowed you to set aside ever-increasing sums towards investment in the shares of Shoprit as they reached their lowest point each year.

So, if you follow my table above you will note that ten years on you would have accumulated a total of 21 505.62 shares worth, at their peak price on August 30 2012, R172.29 each. That is a total of R3 705 203.

If you care to calculate this process you will see that your investment growth rate from the point you entered the share market with an initial R50 000, would work out at compound 48% – nearly twice the 27.47 percent compound average rate that the share price was growing over the same period. Were you simultaneously to have re-invested the dividends received from these investments at an average yield of 2.7 percent yearly, you would have grown your capital to a total of R4.65-million in ten years.

Were you, furthermore, to have continued this process for just one more year you would have achieved a capital sum which, invested at the Shoprit average dividend yield of 2.7 percent, would have provided you with an annual dividend income equal to your annual salary which, by then assuming that the annual increments were a constant 10 percent, would have equalled R519 000. In addition, assuming Shoprit remained the well-managed corporate that it has been for its long past history, you might comfortably assume that its continuing dividend growth rate would offer you year by year a steadily-improving standard of living; one moreover that you would never have afforded if you had simply relied upon a salary growing at 10 percent a year.

So to recap, the way to becoming a ten minute millionaire is:

1) Save a minimum of ten percent of your gross income

2) Create a list of companies whose dividend payouts have increased steadily for the past decade.

3) From this list select all those whose shares are traded daily in volumes in excess of 1-million.

4) Rank the shares that remain in descending order of dividend growth over the past decade.

5) And that, dear reader, is all it takes to achieve financial independence in just eleven years and serious wealth in only a few additional years. If, furthermore, you can learn to buy only when your chosen shares are priced at the bottom of their annual price cycles, you can double your annual average capital growth rate.

Now you need to recognise that to keep this calculation simple, I did not add in brokerage costs, but neither did I allow for any interest that his annual savings might have brought in, so it is fair to assume that, since interest rates are far higher generally than brokerage ever is, our investor would have achieved a far greater sum to invest. However this gain might have been reduced by the fact that it is well nigh impossible to always buy shares at the lowest possible price.

Nevertheless, the point is obvious, that regular purchases of high-growth shares can quickly enrich people. In this case it is clear that in just a few years a middle-income South African can become a millionaire if he or she makes the right share selection choices and keeps a beady eye upon the market in order to buy at the most auspicious point in that share’s annual price cycle.

Of course it is not smart to invest in just one share because you would radically increase the probability of losses should you need to realise cash for some emergency at a time when share prices were exceptionally low, but other than that, there is nothing difficult about getting on the road to riches!

That’s it then: If you can take to heart just these five simplest of rules, you have it in you to become one of the richest people in the country.

Of course there is a lot more to learn about how to fairly price a share, how to measure when a share is reaching its price lows and highs, how to balance a portfolio and diversify your risk, all of which are subjects for my Master Class. The rules for these are just as easy to learn as the five I have outlined in this simple series.

If you would like to continue with my Master Class and earn a diploma at the end, then just click the “I want to continue” box below.

Decision Time: Just tick the boxes!

□ I am putting aside a tenth of my income each month and in preparation for entering the share market I have been saving in a savings bank that currently offers me the highest possible interest rate.

□ I want to become seriously wealthy and I understand that only through investing in blue chip shares is this possible.

□ I want to continue learning because understand that so far I have only been taught the basics of successful Blue Chip share selection and that there is a lot more to learn. I therefore commit to participation in the RCIS Master Class which will cost me just $50 more.