Buying and Selling Shares
How to buy Shares
For most share dealing, you will need a broker. The Stock Exchange will provide, in addition to several useful booklets about investment generally, a list of brokers prepared to deal for small private clients. Provincial brokers will usually be cheaper and have a reputation for being more approachable.
Ensure that the broker is regulated by the Financial Services Authority (FSA), which has a compensation fund. This will reimburse most, or all, of the loss suffered by private clients in the unlikely event of a broker going out of business before a transaction is completed. Some brokers are also well insured against losses.
For investment in the savings schemes of an investment trust, write directly to the trust's managers asking for an application form for the scheme. A list of trust managers and their addresses can be obtained from the AITC.
Buying Shares
Suppose you want to buy shares in a company XYZ whose middle price in today's paper is 105 pence.
* Phone the broker (ask for him by name), then give your name and probably your account number.
* Ask 'What price is XYZ?'
The broker will reply something on the lines of 'Buying price 110p, selling price loop', or even just '100-110op'.
* If you don't like the current buying price (110p), just say 'too much' or 'not interested' and there is no further obligation.
* Otherwise, give your order such as 'buy one thousand XYZ at maximum 110 p'. It is strongly advisable to state a maximum price (buying) or a minimum price (selling). Never say 'at best '! However, you might be willing to say 'at maximum 113p'.
Get the broker to repeat this order to you, especially if you are placing several orders at once, otherwise embarrassment could be caused.
Virtually all brokers now tape-record their telephone calls.
* That ends the transaction.
* Say 'goodbye' and ring off.
* Once you have rung off, you cannot change your mind.
You should receive the Contract Note the next day. It will state exactly what has been done for you by the broker, giving the full price including details of the commission, stamp duty (where appropriate) and the Stock Exchange levy. Check that the details agree with what you wanted, complain if they do not.
Later, you will receive a statement, listing all your transactions and requiring settlement by the stated day. You write out a cheque, make it payable to the broking firm (not to the individual broker) and post it off with your client number or other form of identification so as to arrive before the stated day. It is necessary to take action to ensure that you have cleared funds in the bank in time to meet the cheque. If you normally keep the money in a building society, it will have to be transferred to your bank account in good time.
Owing to a number of frauds perpetrated on cheques 'lost' in the post, the Cheques Act (1992) provided that cheques crossed 'A/C Payee only' could only be paid to the bank account of the named individual or company.
Important - purchases of gilts and traded options must be settled on the next working day after purchase. Unless you live next door to the broker, this requires that you leave a sufficient sum on deposit with the broker before making the purchase. Some brokers will allow late settlement of gilts - ie on Account Day - for a slightly higher purchase price.
In order to purchase shares in an investment trust through its savings scheme, it is necessary only to fill in the form and send a cheque. Make sure this will arrive in good time before the day, usually at the end of the month, that the trust buys the shares on the open market.
Retain all the contract notes for possible inspection by the Inland Revenue. Keep old notes for seven years. After weeks or months, your broker or the investment trust will send to you the Share Certificate. You were, however, the owner of the shares as soon as you bought them and have a full entitlement to any dividends which they paid after that date.
When to sell:
Ideally, we should sell when a stock reaches its fair value. There are 9 other reasons to sell but I won't cover it here. So, what is a stock's fair value? I have covered this plenty of time. But, in general, a stock reaches its fair value when it is yielding 3% above the current free risk interest rate. I am using 10 year treasury bond as a proxy for free risk interest rate. Currently, the 10 year bond is yielding 4.46%. Fair value of a stock is therefore when it is yielding 7.46%. Inverting yield, we then got the widely used Price Earning Ratio. Yield of 7.46% corresponds to P/E ratio of 13.4
When to buy:
This is an easier question to answer. We, of course, should buy stock lower than we sell. If we sell the stock at a P/E ratio of 13.4, then we should buy it when the P/E ratio is less than 13.4. How much lower ? It depends on how much return you aim for. If, say, you are aiming for 50% return, then your buying price is when the stock is trading at a P/E of 8.93. If you are aiming for a 34% return, then your buying price is at a P/E of 10.
In short, we should buy at a P/E of 8.93 and then sell at a P/E of 13.4, correct? Yes, but with a lot of caveats. I've covered those caveats in 5 common misuse of P/E ratio. To emphasize, the P/E ratio used here is not trailing P/E ratio, does not ignore the value of cash in the balance sheet, does not ignore one-time event and does not ignore the change in interest rate. At this point, I am ignoring earning growth simply because the fair value calculation is for a company with 0% growth.
