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How to select shares

Six common sense strategies, used by successful investors, to identify shares with potential Plus, a basic guide to fundamental and technical analysis

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Online/Self Invested SIPP Hargreaves Lansdown

CONTENTS

CONTENTS

pg 3

Introduction Why pick shares? What this guide will tell you Part A. Get the idea Method 1: Economic cycle Method 2: Big Themes Method 3: Scuttlebutt Method 4: Directors dealings Method 5: Newspapers and magazines Method 6: Excessive falls Get the idea - Summary Part B. Analyse the Company Fundamental Analysis 1. Performance (Prot Margin) 2. Sustainability (Gearing) 3. Value (PE Ratio) Fundamental analysis - Summary Technical Analysis 1. Trends 2. Support/Resistance Fundamental or technical analysis? Conclusion

pg 4

pg 12 pg 12

pg 16

pg 19 pg 19

IMPORTANT INVESTMENT NOTES All investments should be held for the long term as their value can fall as well as rise, therefore you could get back less than you invested. Unless otherwise stated investments do not provide the capital guarantees of a deposit account. Similarly any yields will vary over time, so income is variable and not guaranteed. This is designed as a guide for information purposes only and is not a personal recommendation. If you are unsure you should seek advice. May 2012

02 | HOW TO SELECT SHARES

INTRODUCTION

INTRODUCTION
Why pick shares?
In 2008 the FTSE All Share Index fell 33%. It was a terrible year for shares. However, in that year 225 of the 570 shares in the FTSE All Share beat the Index. The share price of three shares, Telecom Plus, Randgold Resources and BTG, increased over 50%; pharmaceutical giant AstraZeneca rose 30%. In the following year, 2009, the market bounced back and the FTSE All Share Index increased 25%. That year 340 of the 570 shares in the FTSE All Share beat the index, with 100 shares increasing by over 100%. The lessons we can draw is that in every year the overall index can mask the performance of individual shares. Even in a disastrous year like 2008 there will be some shares that perform strongly. The challenge for investors is to identify those shares.

What this guide will tell you

The purpose of this guide is not to say selecting shares that perform is easy; it is certainly not without risk. However, it can be a lot easier than you think. Success in share investing is not a matter of having a PhD in mathematics or just looking at past performance, rather it involves the application of common sense and a disciplined approach. This guide aims to tell you how to get started with this. Before you go any further you should be fully aware of the risks of investing in shares. Whilst there are always shares that outperform the market, there are also those that significantly underperform. Risk and reward go hand in hand, no matter how confident you are about a particular share, you must be aware that they can fall in value, and you could get back less than you originally invested. When you think about buying shares, but you dont have a particular share in mind, you need some ideas for which companies to buy. Where do you find these companies? Thats what the first part of this guide is about it lists six different methods used by successful investors to identify interesting shares. This is not an exhaustive list. You can use some, all, or none of these methods, they are just here to give you some ideas and a simple starting point. Having found one or more possible shares to invest in, you may wish to take a closer look at each company to see if it will make a good investment. The second part of this guide explains how to do this with a set of simple analytical tools.

Lets get started.

HOW TO SELECT SHARES | 03

PART A. GET THE IDEA

PART A

Get the idea

Six methods for nding attractive shares

Method 1. Economic cycle

Over time the economy goes through periods of growth and periods of contraction. This economic cycle is natural and has recurred throughout history. This cycle can be very useful to investors. However, it should be noted that the economy and the stock market do not move in tandem. This is because the stock market is usually seen as anticipating changes in the economy. If, for example, the economy is expected to accelerate in six months time, then investors will buy shares now they wont wait for this to actually happen. Therefore, when considering the economic cycle, investors should take into account that share prices will generally anticipate changes in the economy that are expected six to eighteen months ahead. The economic cycle allows us to classify shares into two types: i). Cyclical shares Cyclicals are companies whose fortunes are intrinsically linked to the health of the economy, increasing their profits and dividends in the good times but suffering in the downturns. When we have to tighten our belts we decide we can do without luxury handbags and world cruises. We postpone buying a car and find that mortgages are harder to come by. It is difficult to judge when the market has hit the bottom but if you get on the bandwagon just as it starts rolling you can buy in comparatively cheaply in the hope of selling before the economy starts to slow. Bear in mind that in downturns cyclical shares are not all hit at the same time - for instance, retailers feel the brunt of reduced consumer spending immediately; their suppliers and distributors then feel the knock-on effect as the shops reduce their orders; makers of components and producers of raw materials come into the cycle last.

04 | HOW TO SELECT SHARES

PART A. GET THE IDEA

If you are thinking of investing in cyclical shares, look for those companies: with strong balance sheets and little or no debt that anticipate downturns or react quickly by reducing staffing levels, cutting poor selling lines or abandoning unprofitable markets that do not expand too rapidly in an upswing and thus avoid overstretching their financial and management resources where you believe the fall in the share price has factored in all the bad news and then some more ii). Defensive shares Defensives are companies that sell pretty much the same amount of goods or services whatever the state of the economy. They do not enjoy the boom times as cyclical shares do but neither are they set back so badly in tougher times. They are referred to as defensives because they are seen as a potential line of defence when share prices are falling. The introduction to this guide mentioned that shares in the pharmaceutical company AstraZeneca rose 30% in the otherwise dismal 2008. It didnt take a genius to work out that even in a financial crisis people still need to buy pharmaceuticals a good example of a defensive share. It is also a good example of how much of investing is just common sense. Of course, no sector is entirely recession-proof. Supermarkets seem superficially to be immune from a downturn as we all still have to eat, but we can switch to cheaper foods and drinks, thus putting pressure on profit margins. Therefore defensives can also fall in value too. One significant difference between the two types

of company is worth noting: defensive shares tend to have greater visibility of earnings; that is they have contracts that guarantee revenue for months or even years to come. Such companies generally represent more stable investments than those living hand to mouth. If you are thinking of investing in defensive shares, look for those companies: with good visibility of earnings selling goods or services that are in continuous demand with a good geographic spread of markets with attractive dividend yields The following table gives some examples of the major cyclical and defensive sectors. Cyclical sectors
Aerospace Automotive Banks Construction Engineering and Industrials Media Manufacturing Mining Property Retailing Travel & Leisure

Defensive sectors
Food Beverages Healthcare Household goods Insurance Pharmaceuticals Support Services Tobacco Water

TIP
When considering shares to buy, bear in mind the prevailing stage of the economic cycle. In theory, when the economy is growing strongly, cyclical shares tend to perform well; while in a downturn defensive shares should if not perform strongly at least outperform cyclical shares.

HOW TO SELECT SHARES | 05

PART A. GET THE IDEA

Method 2. Big Themes

The first method of finding share ideas depended on the economic cycle; we will now look at a method that tries to look beyond the mediumterm cycle and focuses on the longer term. One of the major themes of the 21st Century is likely to be the continued development of the emerging economies and the huge expansion of the middle classes within those countries. This can lead to many investment ideas. For example, luxury consumption of cars, fashion, wines and other items are likely to soar in the emerging economies leading to strong demand for companies active in these areas. Other Big Themes are likely to be the aging population in developed markets, increasing urbanisation, and the tasks of feeding the world and powering it. The following table lists a selection of Big Themes for the coming century and an example of the type of company that stands to benefit. Of course, there will always be a large element of guesswork with such predictions, but the investments that do come right can benefit investors for decades. Within each theme some Sector
Education

companies will thrive while others will fail to take advantage and get left behind losing money for their investors. Investments made using Big Themes thinking should only be made with the longer term in mind. Company examples
Pearson

Theme
Education is soon to become an integrated, global, digital business with demand and innovation driven as in so many (other) areas - by the emerging markets. Global healthcare spending is set to soar with a combination of people living longer in developed countries and middle-class consumer populations growing in emerging markets. The urbanisation and infrastructure development of China and other emerging markets is likely to provide strong demand for resources for a period of many decades.

Pharmaceuticals

GlaxoSmithKline

Mining

Rio Tinto

Luxury consumption Africa

The global middle class is set to expand rapidly as emerging economies Burberry become wealthier. As this happens consumption will increase, especially the discretionary element where brand names are all-important. China is investing billions in Africa's resources which will help trade and economic growth there for decades. But Africa is also growing internally with a booming middle class that should drive consumption. PZ Cussons

06 | HOW TO SELECT SHARES

PART A. GET THE IDEA

Method 3. Scuttlebutt
Peter Lynch was a fund manager who believed that you can turn personal experiences as a consumer into good investment opportunities. For example, he liked the doughnuts at Dunkin Donuts and the beds at a particular motel chain so much that he bought the shares. It obviously worked for him; he managed the Fidelity Magellan Fund one of the most successful funds in history. Lynch said: Every time you shop in a store, eat a hamburger or buy new sunglasses you're getting valuable input. By browsing around you can see what's selling and what isn't. This idea of using personal experience to influence your investing decisions was originally proposed by Philip Fisher who called the process scuttlebutt*. The great thing about scuttlebutt is that all investors can use it, and their experience can be just as valid as highly-paid fund managers (who probably dont get out that much anyway). Scuttlebutt research is easy. Next time youre in the high street, see which shops seem to be busy or those shops that seem rather too quiet and just generally unattractive. If you take easyJet flights and find them nearly always full, perhaps the company is worth looking at. If budgets are biting and you decide to stay in a little more frequently and order a Dominos pizza, perhaps others are doing the same. Scuttlebutt may seem too easy, but dont dismiss it often this subjective experience can be more valuable than the seemingly more objective, but academic, views of analysts and newspaper columnists. Stock market research is often based on historical performance, but your own experiences can show you exactly whats happening right now.

TIP
The internet offers great opportunities to extend the power of scuttlebutt research beyond personal consumer experience to see feedback from thousands. Obviously, one must weigh carefully anything on the internet, but it is certainly a useful additional tool to research a companys products or services.

Method 4. Directors dealings

Towards the end of April 2010, after a period when the shares had been gently falling, a C J Humphrey, C M Brendish, D A Hurst-Brown and R Amos all bought shares in IT company Anite. A few weeks later the shares started climbing and a year later had doubled in value. The question is: who are these four people and what did they know? We dont know what they knew, but we do know who they are they were all directors of Anite.
this would give them a better idea about life on the ship. HOW TO SELECT SHARES | 07

Throughout the year there are certain periods when directors are not allowed to buy and sell shares in their company because they have access to certain privileged information (e.g. in the period just before results are announced) but for the rest of the year directors can deal in their company shares just like any other investor. The LSE must be informed of all such dealings and this information is then widely disseminated. Some investors closely follow the dealings of directors, in the not unreasonable belief that the

*Scuttlebutt is an old naval term for gossip or rumour. Sailors would talk around the scuttlebutt (water barrel on a ship) and

PART A. GET THE IDEA

people who understand a company best are its own directors. There are many ways to interpret directors

dealings. In some cases, such as the chart below, after a quiet period director buying activity can signal that something is about to happen. Note: Past performance is not a guide to future returns.

ANITE PLC AIE

78 73 68 63 58 53 48 43 38 33 28
09 Sep 09 Dec 1 Mar 0 10 Jun 10 Sep Dec 10 11 Nov

(p)

Shares bought

In other cases, directors buying after a big fall in the shares can indicate that the directors simply believe the extent of the fall is unwarranted and that the company is still sound. On 9 November 2011 Admiral shares fell over 25% following a negative reaction to the companys

third quarter results. Seven directors felt the selloff was overdone and invested a combined 11.1m in the shares. In the following months the shares recovered most of their losses from that day, and in March the company released record profits for the eighth consecutive year.

ADMIRAL ADM
1500 1400 1300 1200 1100 1000 900 800 700
Sep 11 Oc t 11 11 Nov 1 Dec 1 12 Jan 1 Feb 2 M ar 12 12 Apr

(p)

Shares bought

08 | HOW TO SELECT SHARES

PART A. GET THE IDEA

This can also sometimes be seen market-wide. In retrospect we can see that after the financial crisis of 2008 the market bottomed in March 2009 and then bounced back strongly. However, at the time, in March 2009, it wasnt at all obvious that that was the bottom it never is obvious at the time. But an exceptional number of directors bought shares in their own companies between January and March 2009. They evidently did not

believe that the level of share prices reflected the underlying fundamentals of their companies this was a great signal that shares had been oversold. Directors dont always get it right. In March 2006 there was a frenzy of excited directors buying shares in Paragon at a price which turned out to be a bubble peak for the shares. Their error was compounded when they tried to double up by buying on the way down as well.

PARAGON GROUP OF COMPANIES THE PLC PAG

(p) 800 700 600 500 400 300 200 100 0
May 05 05 Nov May 06 06 Nov May 07 07 Nov May 08 08 Nov

Shares bought

A few guidelines for interpreting directors dealings:

Small deal sizes (e.g. below 2,000) and regular deals are not considered significant. Deals can be considered more significant if there are many directors dealing at the same time, especially if this includes the finance director. While directors buying shares can be seen as a vote of confidence in the company, the reverse is not necessarily the case. Large scale sales of shares by directors can be viewed as negative by the market, as it can signal the directors have less faith in the company, or indeed that they believe the share price has risen far enough for now. However, this is not necessarily the whole picture. A director may sell shares for many reasons for example, they may want to raise money to buy a house or pay the childrens school fees. So it is more difficult to interpret directors selling deals.

TIP
Directors dealings can sometimes provide great signals for share price movements. But remember, the buying signals are more reliable than the selling signals.

HOW TO SELECT SHARES | 09

PART A. GET THE IDEA

Method 5. Newspapers and magazines

Many investment ideas can be found in the stock market columns of newspapers, magazines and online, where theres no shortage of tips, tips, tips. All this can be useful; however it is wise to bear in mind a couple of things. First, if you are investing in shares for growth, then you make money when you sell the shares (not when you buy them). Therefore, when you sell is important. However, if you buy a share solely as a result of a tip and for no other reason you may not know when to sell it. Because of this it is important to only use tips as a starting point for doing your own research. Having done your own research you will be better equipped to know when to sell the shares. The second thing to be aware of is that when a share is tipped in the media its price can jump up immediately, simply due to the increase in buyers, and may then slip back again as the buying pressure reduces. This is usually only an issue with smaller companies who have less liquidity in the market but it is important to check the price at the time the tip was released to see what movement has occurred before you buy; in most cases this will be quoted in the tip.

Method 6. Excessive falls

On 12 January 2012 shares in technology company Invensys closed at 227.1p. The following morning the company released a statement saying that its profits for the year would fall 60m short of expectations. The shares reacted immediately, opening at 168p and closing the day down 19% on the previous day. A huge fall in one day. That is the danger of profit warnings shares can react extremely sharply. However, it can also be an opportunity. Take a look at the following chart of Invensys shares over this period.

INVENSYS PLC ISYS

235 225 215 205 195 185 175
12/1 2/11 22/1 2/11 1/12 01/0 1/12 11/0 1/12 21/0 2 / 12 31/0 2 / 12 10/0

(p)

10 | HOW TO SELECT SHARES

As can be seen, just three weeks later the shares had bounced back to their previous levels. This is fairly common. The market can over-react to profit warnings and the shares become over-sold. The opportunity here was to recognise that the shares had been greatly over-sold and to buy them after they had fallen 19% on the day of the announcement. A similar behaviour can also be seen sometimes when companies announce good results. There is an old stock market adage which says: buy on the

rumour, sell on the news investors cash in on good news and their selling forces the price down, which can then create opportunities for the nimble and level-headed investor. This method of selecting shares is not without danger. Sometimes shares fall for a very good reason and continue falling. The skill is in finding companies that are fundamentally sound but have been over-sold in the short term.

SUMMARY

Get the idea

We have listed six dierent methods for nding ideas for shares to buy. None of them is necessarily better than the others. Investors should be like magpies willing to collect ideas from anywhere. Hunches are also ne. If you wake up one morning and think sausage skins! (Devro PLC), go with it. Once you have got an idea for a share, you may simply go with your hunch and buy, but you might also want to do some simple research on the company - which is the subject of the next part of this guide.

HOW TO SELECT SHARES | 11

PART B. ANALYSE THE COMPANY

PART B

Analyse the company

In this second part of the guide we will look at two dierent ways of analysing companies: 1. Fundamental analysis (which assesses the health of a company through analysis of the gures in its prot/loss report and balance sheet). 2.Technical analysis (which analyses the historic behaviour of the share price).

Fundamental Analysis
When planning to buy a second-hand car, you might think of three things: 1. Performance. How fast does the car go? How efficient is it? 2. Reliability. What are the chances of the car breaking down? 3. Value. Is the seller asking too much? We are going to look at analysing a company using the same three criteria (although instead of reliability, in the case of shares well call it sustainability). The car-buying analogy is not perfect, but its good enough to get us started. One way to do this is to look at how much profit a company makes for every 100 of goods or services it sells. This is called the profit margin and is defined as: profit margin = net profit sales revenue

1. Performance (Profit Margin)

When analysing a company the first thing we want to do is to assess whether the company is any good! Is it making good profits?

The result is usually expressed as a percentage. The average profit margin for companies in the FTSE 100 Index is around 17%. Currently Next has a profit margin of 16%, while Diageo has a profit margin of 24%. Profit margins do differ somewhat between sectors; supermarkets tend to have margins in the single digits, while pharmaceutical companies can have margins over 30%. Profit margins are not usually calculated for financial companies.

TIP
When assessing the profit margin of a company it is useful to compare it with the margins of other companies in the same sector.

If the company passes the first performance test, the next criterion to address is sustainability. There are many ways of looking at this; in this guide we will focus on the size of a companys debt. A certain level of debt can be beneficial for a

2. Sustainability (Gearing)

12 | HOW TO SELECT SHARES

PART B. ANALYSE THE COMPANY

company, but beyond a certain point there is a danger of a company being overwhelmed by too much debt. To assess debt we will use a measure called gearinggearing = total borrowings cash shareholders equity

scramble to reduce debt when the cycle turns down, especially if interest rates are rising. There is no set level for gearing, nor even a guide level at which alarm bells should start ringing, although you would normally expect gearing to be less than 100%. However, companies with particularly high capital costs such as plant hire or construction groups always have high gearing, usually above 100%. Typically, bankers and lenders have liked to see gearing of no more than 50%. If gearing is above this level, investors would have to consider whether a company would have problems borrowing more money at reasonable rates.

Where shareholders equity is the companys total assets less its liabilities. Again, the result is usually expressed as a percentage. The higher the figure, the more potentially overstretched the company is. The lower the figure, the less onerous the interest burden will be. Gearing goes in and out of fashion. Running up debts to gear up the business magnifies profits in the good years but it has the opposite effect in the bad years. Thus gearing tends to be popular when the economic cycle turns upwards but there is a

We may find an attractive company (one that is profitable and has low debt), but it will not be useful to us if the shares are priced very high because many other investors have already bought the shares. So, now we need to look at value. We need to assess whether the shares are priced cheaply or expensively in the market.
HOW TO SELECT SHARES | 13

3. Value (PE Ratio)

PART B. ANALYSE THE COMPANY

Imagine you are a billionaire and you are thinking of buying a whole company for 200m, what sort of profit would you want to see that company make annually? Perhaps, 20m. 40m would be better. But if the company was only making, say, 5m would you still buy the company for 200m? Perhaps not. If the company was making a profit of 20m, youd be paying 10 times (200/20) the annual profits to buy the company. If the company was making, say 40m profits, then youd be paying 5 times (200/40). And, if the company was only making, say, 5m profits youd be paying 40 times (200/5). This relationship between the value of the company in the market and its profits is one of the most important in share investing and is called the PE ratio, or just PE in most cases. The formula is usually expressed as: PE ratio = share price earnings per share

How to calculate the PE ratio When we come to calculate the PE ratio, the share price is easy to determine - we just look at the stock market and see what price the shares are currently trading at. But we have a choice when it comes to the figure for earnings per share of using: Historic earnings these are the actual earnings reported in the most recent company report Future earnings these are the forecast earnings for the coming year The choice of which earnings figures to use can have a significant effect on the calculated PE. For example, at the time of writing the engineering services company Babcock has a historic PE ratio of 26 and a forecast PE ratio of 12. The attraction of the historic ratio PE (i.e. the PE ratio calculated using historic earnings) is that the earnings figure is historic fact and easy to find. The PE ratio will
14 | HOW TO SELECT SHARES

also vary depending on the share price. Therefore it is important to calculate the PE ratio using the most recent share price. The PE ratio quoted in the fundamental data of a company will be based on the share price at the time of the report. How to use the PE ratio The PE ratio is useful as it allows us to compare the market price of a company with those of other companies, a sector or the stock market as a whole. As a general principle, the lower the PE, the

PART B. ANALYSE THE COMPANY

cheaper the shares are but beware, as there may be a reason why shares are going cheaply. The average PE for the UK market tends to settle around 14 but it partly depends on the outlook for the economy. Many companies, including sound ones, were down to single figures in the recession because investors fretted over whether earnings could be maintained. PE ratios differ between sectors. For example, slow growing utility companies usually have low PE ratios (below 15), while high growth companies, like technology companies, have high PE ratios (over 30). Investors can use PE ratios to compare shares. For example, if Sainsbury has a PE ratio of 9 and

Morrisons a PE ratio of 12, one could say that Sainsbury is undervalued relative to Morrisons (if one also believes the prospects for both companies are similar). However, if one believes that the growth prospects for Morrisons are better than Sainsbury, then it is a case of trying to quantify how much better they are and whether Morrisons deserves a PE ratio 30% higher than Sainsbury. Investors looking for share price gains will want to find fast growing companies. And, fortunately, its not difficult to find them. The problem is that in most cases that fast growth will already be reflected in the high price of the shares (i.e. the shares will have a high PE ratio). The challenge for the investor is to find companies whose growth is not yet fully reflected in the share price.

SUMMARY

Fundamental Analysis
In this section we looked at three ratios used in fundamental analysis. In practice, there are many more ratios that investors can use the three here were chosen because they are straightforward and accessible.
Criteria
Performance Sustainability

Ratio
Prot margin Gearing

Notes
The higher the better. Gearing can be good when the economy is strong and dangerous when the economy is weak. Be wary of very high gearing. High PE ratios can be justied if a company is growing fast. Investors look for companies where the PE ratio does not fully reect the growth prospects.

Value

PE ratio

As investors become more experienced they can use more complex ratios, and those customised to their particular investing approach. However, more complex does not always mean better. The key for investors is to use a disciplined approach that they are comfortable with.

HOW TO SELECT SHARES | 15

1. TRENDS

Technical Analysis
Some investors (often called chartists) believe that an understanding of the past price behaviour of shares can give a clue to future performance. Chartists do not believe that all price movements are random; they believe that prices occasionally form patterns that can affect how a price will behave in the future.

In this guide we will look at two basic concepts of technical analysis: 1. Trends 2. Support and resistance levels These can be useful tools but should not be used on their own. Investors should also concentrate on a companys future prospects.

1. TRENDS Share prices rarely move in straight lines a typical share price chart displays a series of jagged moves. However, in the chart below it doesnt take a huge imagination to see a pattern: the line moves fairly steadily from the bottom left of the chart to the top right. Drawing some lines on this chart to highlight the pattern helps. Although the price has not been moving in an absolute straight line, it has been moving steadily in a certain direction within a fairly tight range. The outside straight lines drawn on this chart are sometimes called trend lines.

CARILLION CLLN
500 450 400 350 300 250 200 150 100 50 0
03 Jan 03 Sep May 04 05 Jan Sep 05 May 06 07 Jan 07 Sep

(p)

This pattern lasted for a fairly long time, almost ve years. Some chartists hope to spot such patterns and will buy the shares to ride the trend. A popular saying in these circles is the trend is your friend. This saying is sometimes extended to the trend is your frienduntil it ends.

But when does a trend end? Much work is put in by chartists involving complicated calculations trying to judge when a trend has ended. At its simplest, we could say that a trend ends when the share price breaks decisively through a trend line. The following chart has extended the period of the chart to January 2009.

16 | HOW TO SELECT SHARES

1. TRENDS

CARILLION CLLN
600 500 400 300 200 100 0
J an 03 Jan 04 Jan 05 J an 06 J an 07 J an 08 J an 09

(p)

Linear (Series 1) Series 1 Series 2

We can see that the break through the trend line in December 2007 was the decisive end of the upward trend, and the shares fell afterwards.

Trading with trends is one of the most popular strategies for chartists. Whole books have been written on how to

spot trends and the tactics for exploiting them.

2. SUPPORT/RESISTANCE
Sometimes one can see price levels on a chart through which the share price seems reluctant to break.

As can be seen, throughout a seven-month period the share price of United Utilities repeatedly moved up towards a level around 635p and each time fell away. After a while such behaviour becomes self-fullling: as more traders notice that the price failed to break through this level before, when the price moves again up towards

this level traders will be tempted to sell (in anticipation of the price falling away again), and their action of selling will put downward pressure on the price. Other participants may at least hold o buying the shares near this level which will lead to weak demand and enable the price to fall away easily. This level through which the price is reluctant to move is called a resistance level.

UNITED UTILITIES UU.

700 650 600 550 500 450 400
09 Nov 1 Feb 0 May 10 Aug 10 10 Nov 1 Feb 1 May 11 Aug 11 11 Nov 1 Feb 2 May 12

(p)

HOW TO SELECT SHARES | 17

2. SUPPORT/RESISTANCE

A similar thing can also happen below the price. Take a look at the following chart. Over four months, the share price of Spirax-Sarco

Engineering fell repeatedly to the 1800p level, each time to bounce up o it. This 1800 level is called a support level. Again, after a while, such behaviour can become selffullling as more traders notice what is happening.

SPIRAX SARCO SPX

2050 2000 1950 1900 1850 1800 1750
1/10 22/1 0 12/1 0 6/ 12/1 20/ 0 1 01/1 03/ 1/11 17/0 1/11 31/0 14/0 2/11 11 02 / 28 /

(p)

Sometimes resistance and support levels can form at the same time and the price can bounce between them in a range. For a few months the Yule-Catto share price seemed unable to break out of the range 148-180p.

The theory is that after such a range has become established, when the price does eventually break out of the range, the price can move decisively further in the same direction. In this case in January 2012 the price broke through the resistance level of 180p and moved quickly higher.

YULE CATTO YULC

(p) 210 200 190 180 170 160 150 140 11 Aug
11 Sep 11 11 Nov 11 12

Oct

De c

Jan

18 | HOW TO SELECT SHARES

FUNDAMENTAL OR TECHNICAL ANALYSIS?

Fundamental or technical analysis?

Strict fundamental analysts would never use charts. For them, squiggly lines have as much to do with identifying undervalued companies as tea leaves or chickens entrails. For their part, strict technical analysts think that fundamental analysis is simply a waste of time. All the analysis has already been done and is already reflected in the prevailing share price. So, the question is: should you use fundamental or technical analysis? The answer is either, the choice is yours. There is no right or wrong. Investors who prefer to take a longer-term view tend to use fundamental analysis, while shorter-term investors (and traders) use technical analysis. Why not do what many investors do and use both? Use fundamental analysis to identify good companies and then technical analysis to try and find out when to invest. For example, having identified a good company, look at the chart: 1. If the price is currently in an uptrend, this can act as confirmation that now is a good time to buy. 2. If the price is currently in a downtrend, you may prefer to wait until the trend changes. 3. If the price is trapped below a resistance level, and could be there for months, you may decide to wait until the price has broken up through that resistance level. 4. If the price is sitting on a support level this could give you some confidence that now is a good time to buy with the price seemingly unlikely to fall.

CONCLUSION

The main lessons of this guide are: 1. Be open to investment opportunities everywhere. This guide lists six methods commonly used by investors, but dont feel constrained to use only these. 2. Having identied an interesting company, do the research. You are far more likely to succeed if you learn about any company before you invest in it. 3. There is no overriding need to have a methodology for buying shares. If hit and miss or a pin in the FT Share Price pages works well for you, thats ne. However a more structured approach should aid performance. 4. The most important attributes of successful investors are common sense and discipline. No method of picking shares gives you a guarantee of success every time. However we hope you are able to pick more winners than losers if you follow, and build on, the information in this guide.

HOW TO SELECT SHARES | 19

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n Stop loss and limit orders - Set the price at which you would like to buy or sell particular shares up to 30

days in advance.
n No inactivity fee - You can deal as much or as little as you want. We do not charge an inactivity fee. n Mobile dealing - Deal on your mobile with our FREE app for iPhone and Android. n Easy to manage - Hold all your shares in one place and manage them online whenever you choose.

Receive simple bi-annual statements to help you keep track of your investments.

What else will you receive as a client?

Improve your investment performance and make informed investment decisions with our wide range of tools, tips and regular updates, many of which are available exclusively to our clients:
n View latest share prices, charts and information - See the latest share

prices, graphs, news, research updates, broker forecasts, annual reports and much more.
n Research updates - We provide research updates and email alerts on

our clients biggest holdings.

n Instant stock market news - View the latest market news and receive

up to 3 daily market reports to keep you in touch with the market.

n Free sector reports and share tips - Receive four share tips from

More info? visit www.hl.co.u k

Investors Chronicle every week together with sector reports and featured tips from Shares Magazine.
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