Philosophy of the investment club

Main objective of the investment club

When you set up an investment club, one of the most important things for members to decide is the club’s purpose.

Remember that it is not a way to get rich quickly, but rather a chance to learn about choosing and making wise

investments over the years. To make the venture successful, you must commit to at least three or more years in the

club.

While investment clubs are certainly interested in making a profit, we sincerely recommend that you focus on education

first and foremost. If you are too concerned about making big profits, especially when you are first starting out, your

share selection is likely to suffer. Investment clubs that follow this advice and maximise the educational aspects of their

meetings usually find that profits follow.

Some other goals investment clubs might have are to make new friends and to have fun. There are great opportunities

for new and lasting friendships in your investment club, and this can branch out to activities at regional and national

levels.

The importance of a mission statement

When you get your initial investment club members together, it is important to have the same financial goals for the

club. Successful investment clubs buy and hold shares for the long term. Your mission statement must therefore clearly

state that club members must perform a share selection checklist and gain approval from a majority of members before

transacting. This will prevent someone from acting too quickly based on a ‘hot tip’. You must also make sure that all

club members agree on the investment club’s investing principles. Put these down on paper and vote them in as a club.

Choosing a strategy

It is crucial to your success that you develop and implement an investment strategy aimed at achieving your investment

goals. Too many investors buy a share based on the recommendation of other people without any consideration for

how it fits into their overall strategy.

We encourage investment club members to adopt an investment philosophy that includes

the following points:

• Invest a set amount regularly (usually once a month), regardless of market conditions. This helps you obtain

lower average costs (rand cost averaging).

• Reinvest dividends and capital gains immediately. Your money grows faster when earnings are reinvested, due

to the power of compounding.

• Buy growth shares i.e. companies whose turnover is increasing faster than the industry in general. These

shares offer good prospects for continued growth, and higher dividends and share prices.

• Invest in different industries and different-sized companies. Proper diversification helps reduce risk and

increase opportunity for gains. 

Philosophy of the investment club

Investment club members also need to agree on what type of strategy they will use when

buying or selling a share.

We would suggest that all club members first consider studying the free online tutorials available on the PSG website. The course theory covers everything that

a novice investor would need to make an informed investment decision based on fundamental and technical analysis,

as well as prudent risk management strategies.

If you want more knowledge, you can also read books about successful investors such as Peter Lynch and Warren

Buffet on their approach to investing. You can ask each of your fellow members to read a book and share the different

strategies until you come up with one that works for your investment club.

Also remember that your investment club’s philosophy and strategy can change over time. Just as an individual’s

investment philosophies and strategies vary according to age, financial status, financial commitments, investment

goals and risk appetite, the philosophies and strategies of every investment club will also differ depending on its

membership. Similarly, just as individuals adjust their share portfolios as they move through their life cycles, investment

clubs also adjust their share selection process over time as members age, people retire from the investment club and

new blood joins the ranks.

The investment club strategy

We suggest that the investment club choose a strategy and try it out for at least the first year, after which you can

tweak it as you learn more. Check it out and see if it works as well for your group.

Remember that there are investors and traders. Traders are in this for the short term, and for quick profits. Investors

use their share portfolios to build their retirement funds, and are therefore in this for the long term. Investment club

members must all decide if your club will have a ‘trading portfolio’, an ‘investment portfolio’ or a combination of both.

It is a good idea to focus on building up capital for at least the first three years for your ‘trading portfolio’. You can then

decide to make some money available for trading. However, make sure that you allocate the majority of your funds to

a ‘buy and hold’ or ‘investment’ strategy, and less to a ‘trading’ strategy in a separate trading account.

Trading styles

Trading strategies can be classified as either ‘jobbing’ or ‘swing-trading’. Remember that with all trading, profits are

considered as taxable income.

• Jobbing or day trading is a strategy enjoyed by bold speculators who seek a high degree of excitement

from their stock exchange dealings. Jobbing involves jumping in and out of shares, often taking advantage of

very small price movements. With jobbing, you could buy in at 09h00 and sell out by 12h00! It is, however,

generally a very expensive way of operating for two important reasons. Firstly, tax authorities will have no

hesitation in classifying you as a share dealer. Secondly, because you will be trading very actively, you will be

paying substantial broker’s fees. Jobbing also requires that you also keep your ear constantly to the ground

and have an in-depth knowledge of the market. This can be very time consuming.

• Swing trading is a more leisurely approach to jobbing. Here, you climb in at the bottom of the cycle and

jump out at the top of the cycle, switching your entire equity investment to the money market, and awaiting

the next opportunity to climb in at the bottom. With swing trading, you may do two to three trades per year.

In this strategy, your timing must be spot on. In theory it sounds great, but in practice only the fortunate few

get their timing absolutely right.

Philosophy of the investment club

The investment strategy

Investment strategies aim to achieve steady growth in capital and dividend income over time. This is done by owning

a well-balanced and well-selected portfolio of shares that are considered to be reasonably secure. This is generally

classified as a ‘buy and hold’ strategy. A share portfolio is constructed and adjustments are only made when absolutely

necessary. This is a very sound strategy for any investment club, provided that thorough research has been done and

a well-diversified share portfolio has been put in place.

Within this investor group, there are four investment styles:

• Growth investor: This investor uses fundamental analysis to determine if a company is a worthy investment.

This includes looking at growing sales and earnings, solid profit margins and future business prospects.

• Value investor: This investor also uses fundamental analysis, but concentrates on different numbers. Value

seekers are mainly looking for companies that have very low valuations (e.g. PEG ratio or P/NAV ratio) or have

stumbled. Very cheap shares are sought with signs that they might recover.

• Growth At A Reasonable Price (GARP): GARP investors look for companies that are showing consistent

earnings growth above broad market levels (a tenet of growth investing), while excluding companies that

have very high valuations (value investing). The overarching goal is to avoid the extremes of either growth or

value investing. This typically leads GARP investors to growth-oriented stocks with relatively low price-earnings

(P:E) multiples in normal market conditions.

• Investing for dividends: This is the most straightforward share selection strategy. The aim is to pick

investments that provide a steady and substantial income stream (mainly from dividends), from a combination

of ordinary or preference shares. Usually, it would be the older, more established blue chip or large

capitalisation companies that provide a very predictable earnings stream.

The most successful investment clubs prefer to use fundamental analysis to find very high-quality companies, which

have growing turnover and earnings and have a future so bright that they can buy them today and not sell them for a

number of years. A safe approach would be for investment clubs to implement a combination of the four investment

styles. Then they hold on through thick and thin, as long as the fundamentals remain strong. This is called a ‘buy and

hold’ growth strategy. In the medium to long term, a buy and hold strategy will almost always outpace inflation by a

considerable margin. The investment club also avoids excessive brokerage costs and the possibility that members are

classified as share dealers by tax authorities.

Remember, do not start investing until your investment club has decided what your strategy is going to be. Take your

time on this step. Once a strategy has been formulated and accepted, then the members of the investment club must

stick to it. Everyone must vote.

Reality checks

Almost every trader has experienced the adrenaline pumping effects of a fast-paced market. Many have succumbed to

the rush, and know that it can lead to making hurried and poor trading decisions in spite of all their trading knowledge.

As a committed trader who is always watching the markets, reading the news and setting goals for yourself, you are

likely to experience what is called ‘mental isolation’. This happens when you are so involved in the micro-view of things

that you mistake unjustifiable and hasty conclusions about the market as confident decisions in tune with your mental

edge. It is usually only after you are faced with the results of your decisions that you realise you gave in to the rush.

Successful traders realise that the risk of swaying from their trading plan due to mental isolation is always there. The

risk is associated with being in an environment where there is a barrage of information that is coming at you in a 

Philosophy of the investment club

create a trading environment that helps you to avoid mental isolation. One of the best ways of doing this is to

communicate with other members of your investment club while reading and watching information.

Create a watchlist

It can be overwhelming to choose your first shares.

To simplify this decision, we have designed a few simple steps to help you.

• In the share market, an investment club’s main objective should be to maximise wealth! So begin with the end

in mind and then work backwards.

• How do you maximise wealth on the share market? You maximise returns and minimise risk.

• Before you can make money on the share market, you need to create a share portfolio of high-quality shares

that offer great growth potential. Aim to build a balanced portfolio, using strategies that will help you

maximise returns (buy and hold, swing trading or jobbing) and minimise risk (diversification, portfolio structure

and stop loss strategies). Remember that it is not as important to make capital gains as it is to avoid capital

losses!

• Before you can have a balanced share portfolio, you will need to gain more knowledge about share analysis

techniques. There are two schools of thought: Fundamental analysis (looking at the financial statements of the

company) and technical analysis (looking at charts for the company). If you combine the two, you have what

is called rational analysis. The more informed club members are about a certain industry, sector and share, the

better your success on the share market will be.

• Before you can do any share analysis, you need to create a watchlist of interesting looking shares. It is

impossible to follow the events of every single listed share as an individual investor, but leveraging other

people’s time is one of the main benefits of an investment club.

• To create a watchlist, club members will need to go through a ‘prospecting’ phase. As you gain more

knowledge and experience, you will start refining the prospecting process and adapt it to your risk profile,

available time and the investment club’s strategy.

Prospecting using fundamental analysis

With fundamental analysis, you have to keep a financial diary, in which you must record the financial year-ends of all

the companies that might interest you.

The Calendar

Companies report their financial results twice a year: interim results for the first six months of their financial year and

then year-end results for the whole financial year. As members of an investment club, your preparation for company

results needs to start before the results are released.

On the PSG Wealth trading platform, you will find a useful tool called the “Calendar” under the Research tab.

 

1. The Business calendar displays the date when companies:

• Announce/ release their interim or year-end results

• Hold their Annual General Meeting (AGM)   

Philosophy of the investment club

2. The Event calendar displays the dates when companies:

• Declared a dividend

• Last Day to Trade (LDT) to be eligible for the dividend 

• When companies will pay the dividend

For each share in your portfolio or for those shares in your watch list, you need to know:

1. What is the date that the results will be expected? Usually companies publish their results within three months

of their financial year end, but some produce the figures quicker than others.

2. What earnings results do the members of the investment club expect? Would the earnings growth be the

same as the previous year, better-than-expected or worse-than-expected?

3. What shares in their share portfolio would they rate as a ‘hold’ or ‘sell.’ What shares in their watchlists would

they consider as a ‘buy’ or still a ‘watch?’

If you anticipate good results and you believe that the market in general has not picked up on this yet, then you would

get in now, before the ‘crowd’. Remember, financial results are usually only printed in the financial press two to three

months after financial year-end. This gives you a short window of opportunity to make some money fast!

Alternatively, you could access to the research facilities available on the PSG Wealth trading platform. Research tools

such as the Value and Quality Filter save a lot of time, as they help to narrow down the choice by using 12 fundamental

search criteria. The Company Analysis is a short summary research document on most financial and industrial shares,

which provides all the pertinent research information an investor would need to make well-informed investment

decisions.

Prospecting using technical analysis

With technical analysis, you look at charts using various technical analysis indicators to find shares that are ‘oversold’

or that present a buying opportunity. For example, you might look for shares with prices above their 21- and 40-day

simple moving averages (i.e. bullish), while the relative strength indicator is outperforming relative to the JSE Overall

Index. Subscribe to the datashare download from PSG Wealth and receive the Wen Professional Plus charting software

absolutely free! This technical analysis software will help you track the market, and the shares you are interested in.

The Share Selection Checklist

Share analysis consists of two schools of thought: Fundamental and technical analysis. The Share Selection Checklist

(SSC) (Appendix 9 - page 56) will help you to conduct fundamental and technical analysis to choose your shares. It

will allow you to identify the characteristics of growth shares and plot potential future growth from historical trends.

It also helps you determine a reasonable value for a share, when the share is temporarily on the cheap side of a value

assessment.

While the SSC might seem simplistic to many seasoned investors, it is imperative that both novice and more advanced

investment club members document their share selection criteria and details of their holdings. Likewise it is important

that you set out your investment club’s specific investment criteria. This will eliminate ‘hot tips’ from the neighbour,

or dart throwing.

Remember, the SSC is only what we suggest you use – it is not the be-all and end-all method for getting into the share

market!

Philosophy of the investment club

Objectives of a Share Selection Checklist

Two investors can complete an analysis of the same share, using the same data, and their conclusions might be so

different that an outside observer would not recognise that the same company was being analysed. Why? Because

share selection is highly dependent on the opinions of the person completing the form. There are many opportunities

for you to apply you own judgement by making decisions about a company’s prospects. The SSC is therefore not a

substitute for doing research on a share; it is merely a tool that narrows the focus on some of the most important

aspects of successful companies. The keys to successful share selection are to understand the conclusions of your

analyses, and to learn to apply your own best judgement to those areas that need input.

The rationale behind the SSC can be summed up in two parts:

1. Companies that have performed exceptionally well over the past five or ten years can be expected to continue

performing well over the next five years. In practical terms, this means that it is possible to quantify (to some

degree) the success or failure of a company’s management. If a company has grown revenues and earnings

consistently over the past ten years and the same management team is in place, we can reasonably expect

similar growth in future.

2. It is then important to determine a reasonable or fair price to pay for a share with such prospects.

This method of share selection is ideally suited for investment clubs with a long-term buy and hold strategy.

Share selection shortlist

A share selection shortlist gives investment club members a better idea of how to approach share selection. By a process

of elimination, members have now arrived at a list of shares that show certain minimum winning characteristics. These

are the shares that are the gold nuggets, or the companies that show great growth potential!

The methods used for creating a shortlist below are by no means fool proof, but can give you some guidance. After

studying the market for a while, you might decide to choose shares using your own selection criteria.

Share selection using fundamental analysis

Firstly, look at all shares that have operating profit margins greater than 5%. Then list all shares that have produced

an increase in headline earnings per share (HEPS) of over 15%. The best companies are those that are able to

generate large increases in headline earnings per share. Finally, list all shares that meet the first two criteria and have a

Price-to-Net Asset Value (Price/NAV) ratio of less than two. This will make sure that the shares included in the shortlist

are not overvalued.

Once you have this initial list, list all shares that have an ROE% of greater than 15%. The higher the ROE, the higher

the Price/NAV should be. Finally, list all shares that have an interest cover greater than three times. (This means that

there are sufficient profits to pay the company’s current interest charge three times over.) This is normally the minimum

cover required from an investment, and is one of the most important ratios to consider for financial risk. There are

enough uncertainties about the future of a company without the need to invest in companies with a high risk of

possible bankruptcy! The result will be a shortlist of shares, which can be studied further.

Share selection using technical analysis

We suggest that you use Wen Professional Plus charting software to look at all shares that are trending up in price

(i.e. bullish trend based on cycle analysis, support and resistance trend lines, and moving averages) even though they

might be at or near 12-month price highs. Within the bullish trend, find shares that are also at the bottom of a cycle

(i.e. oversold based upon various technical indicators such as the Overbought/Oversold, Stochastic, Relation Strength

Index indicator (RSI) and Moving Average Convergence Divergence (MACD) indicators).

Next, look at a share’s volume and calculate if it is free-dealing or liquid. Also confirm volume accumulation using the

Volume Price Trend (VPT) indicator. Look at whether a share is outperforming the market relative to the JSE Overall

index based on the Relative Strength indicator. Finally, calculate a price target only if there is a buy signal on the Point

and Figure chart and a price consolidation of at least six (but the more the better). This helps to calculate the reward/

risk ratio. The result will be a shortlist of shares, which can be studied further.

Summary

It is important that everyone in your investment club understands the ground rules before you start. This means making sure

that members are in it for the same reason and agree on your investing strategy and objectives. 

Investment clubs that establish an investment philosophy, clear goals and specific strategies for implementation can and do outperform top fund managers and market averages! It was reported in the Wall Street Journal that more than 60% of investment clubs in the United States produce lifetime average compounded annual returns equal to or better than the share market. That is impressive when you consider that 75% of all professional fund managers fail to beat market averages every year. 

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