“Daddy, will you tell me about how you invest one day?” To my astonishment and delight, this is the question that my younger daughter, Alex, asked me recently.I guess I have been talking to her about my portfolio investments for nearly all her 15 and a half years and she had become curious, bless her. The perfect time arose when I took her from London to the Manchester office of Brewin Dolphin, the stockbroker through which I do most of my dealing.
The partner I have long talked to, Bill Thomson, had agreed to show her around and introduce her to what he and his colleagues there do.
I was intending to give her a list of 10 guidelines that I use when I choose shares but, as the train sped on, I found that 10 were not enough. I ended up talking for the entire journey. So here, much shortened, are the first four rules that I gave her out of about 20. I hope the rest will follow at a later date.
Shelter from tax
Before you even start, dear Alex, think about sheltering your investments from tax. Right now, you don’t have taxable income or capital gains. But one day you probably will. Then you should be putting money into an individual savings account (Isa) or a self-invested personal pension (Sipp). It is intensely frustrating to take a risk, get it right and then find a big slug of your gains taken in tax. It also spoils your decision-making on whether to buy or sell when you have to take capital gains tax considerations into account.
Seek out ‘growth-and-value’shares
This is the most fundamental part of my approach. If you get into the investment business, you will find that some people talk about “value investing” and others about “growth” companies. The kind of share I am always looking for is one that is valued lowly but which is, in fact, a company whose profits will grow – either because of inherent growth, or because of recovery from some temporary setback.
Talking about value, I had to explain what a price/earnings ratio is. This took us quite a few stations but understanding this is absolutely vital if you are going to start choosing shares.
To put it concisely, it is the ratio between the price of a share and the earnings of the company per share. If the ratio is high, the company is said to be “on a high rating” and if the ratio is low it is said to be “on a low rating”. Usually – but not always – a high rating occurs when lots of people love a company and know it is growing fast.
Google and Amazon are on relatively high ratings. But I rarely buy shares in such situations.
I look for shares that are on a low rating but where the earnings (profits after tax) are going to bound upwards. Ideally I am looking for a double-whammy – for the earnings to rise and for the rating to increase. Then one can get a share which triples or more.
Finding a winner like this does not happen every month, or even every year. But it is what I am looking out for all the time.
Follow the charts but do not be aslave to them
Some people have enormously sophisticated, and complicated, ways of following the charts made by a share price over time. They reckon there are certain recognisable patterns that can be a guide to the future. I think this is right. But I also think they put too much faith in them and that some patterns are more reliable than others.
One of the most useful concepts is that of a “resistance level” – a horizontal line across the chart which marks the level which the share price repeatedly goes to but does not breach. It could be a ceiling or a floor. Either way, if the level is breached, it often leads to significant further progress in that direction.
Prefer companies where the management does not have to bepersistently brilliant
I mean – and sorry for any offence – property, mining, farming, ordinary banking, casino companies and so on. I generally avoid ones where the management has to keep on being more clever and more innovative than others. Eventually they will fail. The policy means I miss out on some great gains but also some horrible losses. I have missed out on Apple’s rise but also on the scary falls of Nokia and Research in Motion, the company that makes BlackBerrys.