If connecting to the Internet is not your cup of tea, then another more widely available option is checking your shares through the newspaper. Most Australian newspapers will print the previous days, end of day stock market prices, as well as providing some simple commentary on the movements within the market. The newspaper presents this information in a format that may be unusual if you have never looked in the section before, but after reading this tutorial you hopefully have a better understanding of how it all works!

The majority of these headings are self explanatory except the PE Ratio heading which deserves further discussion. Before reading the following explanation it would be useful to read through the Stock Basics tutorial, in order to gain a fundamental understanding of how the Stock Market Operates.

The PE Ratio is one of the oldest and most frequently used share price indicators, and this is why it is published in most newspapers. The PE Ratio is a calculated ratio of a company’s share price in relation to its earnings-per-share for a whole year. It is useful to know that the average PE Ratio is around 15 to 25, which may not mean all that much yet!

While the calculation of the PE Ratio is a simple one:

The actual basis and reasoning behind why, and how it is calculated is quite complex. The underlying fact you must be aware of when using the standard PE Ratio, is that you are relying on data that is historical. This implies that you analyzing historical data, in order to predict future share price movements, and this always adds an element of risk before even looking at ratio.

However, basically the PE Ratio reveals how much investors are prepared to pay, per dollar, in relation to company earnings. In its simplest form, this means that a PE Ratio of 25 implies that you will be willing to pay $25 dollars for every $1 dollar that the company earns. This is the meaning of the ratio in its most simplistic form, and there are many other factors that must be considered before truly understanding the purpose of the ratio.

For the PE Ratio to be effective, it must take into account both a company’s growth rate, and can only be used to compare companies within the same industry segment. The reasoning behind these two points is explained below:

Company Growth Rate

A company can only grow so fast, and so far, until it reaches a point where investors believe that it cannot grow any further. This occurs because investor emotion is the main driver behind volatility in share market which consequently makes it so unpredictable. The PE Ratio is also affected by this notion.

While the ratio can be getting larger and larger, implying investors are willing to pay more and more for every dollar of company earnings – there is an underlying rationale that this type of growth cannot be sustained, and must eventually reach a point where it will flatten out or decline. The reasoning behind this is correlated to the fact that as the PE Ratio increases, the market is expecting more and more from the company which implies it has to continually produce higher and higher returns. If it does not, its share price will begin to falter, and it is at this point that a reduction in the PE Ratio occurs. Usually companies that have sustained such high growth periods will solidify their positions and ensure that their operating income will continue to prosper into the future. This means that their PE Ratio remains above the market average and still draws investor interest.

Industry Segment

The reasoning behind comparing industry segments, still revolves around this notion of volatility, and realizing that each industry has highly different volatilities factors specific to that industry. For example - typically the food and retail industry remains consistent and produces stable growth rates with medium returns. Contrast this against the technology sector which fluctuates between periods of highly-elevated growth rates, and unstable returns. Attempting to drawing comparisons against these two industries using the PE Ratio would be fruitless because there volatility factors are so different.

So when you begin using the PE Ratio, it is important realize there a number of elements involved. Firstly, a $5 dollar stock with a PE Ratio of 100 is considered a lot more costly than a stock with a price of $200 dollars and a PE Ratio of 10. This is because you cannot just compare too different stocks without taking into account the above mentioned factors. The main problems to be aware of when using the ratio stem from its underpinnings and market movement. The denominator of the ratio is Earnings Per Share and it is important to find out how this figure was derived because it can distort the overall ratio if it calculated incorrectly. For example, if the Last Sale Price was at $5 dollars and the Earnings Per Share was calculated at $0.10 cents then this would mean that PE Ratio is at 50, however if this figure was calculated incorrectly and the true Earnings per Share should have been $0.20, then the real PE Ratio is only 25. It is this sort of distortion that many companies can achieve by altering how exactly Earnings Per Share is calculated and while this will not be explored in this tutorial – it is important to be aware of.

The other main problem with the PE Ratio stems from inflation and its effect on the ratio. If there is low inflation then typically the PE Ratio rises because a company’s earnings are not adversely effected by inflation, which means that the ratio gives a fairly good indication of a company’s performance. Conversely, if inflation is high then the ratio usually lowers to reflect the higher earnings generated by this fact. Therefore, the PE Ratio can consistently fluctuate during periods of volatile inflation, making it important to look at the PE Ratio over a period of time, in order to develop a trend of its movements if inflation is constantly changing.

The best advice that anyone can give you into studying how the share price moves is to look at what investors perceive about a company - whether you do this by researching historical prices in the hope they predict future ones or by studying companies profits to see which one is better - investor perception is the underlying key to establishing whether the price will go up or go down.

Share prices change because of the demand and supply concepts previously explained - if people wanting to buy stocks exceeds the amount of people wanting to sell stocks, then the price is driven up because demand is exceeding supply. On the other hand, if more people are wanting to sell their stocks than people are willing to buy them, the share prices falls because supply is exceeding demand. These basic concepts are fundamental to understanding how the share price fluctuates - what is more difficult to understand is why?

If you can figure out this question - you may become the next Bill Gate or Warren Buffet in terms of wealth. The problem with finding the answer to this question is that there is no one simple solution to it - although many different people have tried with varying degrees of success. The difficultly that arises is that you would be trying to figure out what drives some people to like one stock while other people dislike it completely. The number of differing factors to answer the question is mind boggling although most serious investors think they have it figured out!

The fundamental theory that is most widely accepted revolves around investor perception more so than the value of a company. It is important to realize as an aspiring investor that you cannot value a company by simply looking at its market capitalization - the total dollar value of the company’s shares on the market by calculating all the shares available multiplied by their current share price - and think that you should invest in it. Nor should you value different companies by comparing their shares prices because each company may have a different market capitalization which would give a worthless indication of which one is better. The key is to see what investors perceive about the company first before analysing anything else. After all - simple demand and supply theory will tell you that if people don’t perceive something as worthwhile - there will be no demand for it.

Dividend imputation is simply the process ensuring double taxation does not occur. It does this by giving a shareholder a tax credit for tax already paid by the company. For example, if you are a shareholder in a company and receive a dividend - you must pay tax on the dividend amount you receive because it is income to you. However, you are entitled a tax credit - called a franking credit - for tax that the company has previously paid on profits used to finance your newly acquired dividend. Makes a lot more sense doesn’t it?!

In Australia, in order to complement the dividend imputation process - there are three main types of dividends you can therefore receive. These are fully franked, partially franked and unfranked dividends and all represent different types of dividends because each holds different tax implications. Franked simply means that there is a tax credit attached because the company has already paid tax on the profits as in the example above - partially franked and unfranked are just dividends that have either some tax paid on them or none respectively. The effect each of these has on you is dependent on both your own tax level - called your marginal tax level - and how much tax the company paid before distributing the dividend out to you.

Companies pay a tax rate of 30% which does not change as it earns more or less income as your own tax rate may do. The benefit of franking credits to you is:

1. If your marginal tax rate is higher than the company tax rate of 30% - you will only have to pay tax to make up the difference between your tax rate and the companies.
2. If your marginal tax rate is lower than the company tax rate of 30% - you get a double bonus by not having to pay tax on the franked dividend and also getting a franking credit which can be used to offset tax you would have paid on your income!
3. If you don’t earn enough income to even be taxed or the amount of franking credits you receive, are larger than your total tax debt - from July 2001, your franking credits will get you a refund from the Australia Taxation Office!

Therefore, it is very important to look out for companies that pay dividends and check what type of dividend they are paying. Once you have chosen a company to invest in, consult your financial planner or tax adviser to see in regard to minimizing your tax liability.

The dividend declaration date or dividend announcement date is the date on which the Executive Board releases to the public what dividend entitlement each shareholder is entitled to receive.

Typically on this date if the dividend announcement is lucrative, there will be increased trading activity on the company making the declaration as investors want to receive the dividend entitlement.

The Ex-dividend date is the date whereby any securities purchased from a company will not be entitled to receive a dividend. It is the cut off point for you to purchase stock in the company and still receive a dividend payment - stock purchased after this date are deemed to be ex-sale or ex-purchase securities and don’t get dividend rights. The ex-dividend date is set because companies need to finalize their expenses and establish which shareholders are entitled to receive dividends. Shares traded before the Ex-Dividend Date are termed cum-trading shares because they have with a dividend attachment from the company. These are termed shareholders cum-dividend right attachments.

The Date of Record and Payment Date represent the end of dividend entitlement process. Date of Record is the date whereby the company looks at its share subregister and establishes whether you have cum-dividend rights attachments to ensure that you receive your appropriate dividend payout according to the amount of shares you hold. The Payment Date is the date that the company will mail out the dividend payment to you - usually in cheque form but can also be electronically transferred if requested - and the dividend process is completed.

Dividend Dates

1. Ensure you know the schedule of dates for the company you are purchasing shares, so you can receive a dividend right attachment if applicable.
2. The most important two dates are the Ex-Dividend Date and the Record Date because you must purchase your shares before the ex-dividend date and ensure these shares are settled by the record date. This ensures that you will receive payment as a cum-share rights holder. In our example, these two dates are the 18th and the 23rd respectively.
3. If you wish to purchase the shares just to receive the dividends and then sell them again – you must buy the shares before the ex-dividend date and sell them after the record date to be entitled to the dividends. In our example, this means buying the shares on or before Thursday 17th and selling them after Thursday 24th.

Dividends are not required to be given out by companies, and usually are an added incentive for shareholders to invest. Companies that choose to declare them do so because they have either:

1. Over performed and wish to give their profits back to the shareholders instead of reinvesting these earnings back into the company
2. No longer benefit from reinvesting their profits, and in order to increase shareholder sentiment they pay these earnings back in the form of dividends.

They are also a very good indicator of future company performance, because usually only more established and profitable companies pay them out. If a company believes that it’s retained earnings would be more beneficial reinvested back into the company so that it can drive its future growth higher - these are typically new and establishing companies - it will not choose to pay dividends and shareholders will hopefully see an increase in their investments by a rise in the share price. Equally, even well established companies that decide to pay out dividends still need to retain enough of their earnings to ensure that future business needs can be controlled.

By becoming an owner and having a claim to the company’s assets - you also gain the right to vote at general meetings. The more ownership you purchase, the more voting power you gain and therefore the more influence you control over the companies operation. The level of power you receive is not unlimited so that you can simply ring up the CEO or Board Members and tell them that you think the company is over or under performing - nor does it allow you to start taking chairs, desks and pot plants from the companies offices! It simply allows you to gain one vote per share on who is elected to the companies Executive Board - you hope that your votes will have enough influence to ensure that the best board is selected so the company is ultimately successful. If you only own a small amount of the overall shares and therefore only have a small amount of voting power - your votes may not have a large influence on the overall decision that is made. In this case, you can only hope that those with a lot more equity than you are voting to have the best people run the company, because it is also in their interests to do so.

It is worth mentioning at this point, that when you purchase any equity investment such as a share you are also taking onboard the risk of the company. Since you are becoming an owner, you equally bear the risk that the company may not be successful and your claim on assets should the company have to liquidate (have to sell everything and go out of business) is less than a person who chose to give a company debt financing. This means that shareholders can earn fantastic profits if the company is successful - but equally can lose if the company performs poorly.

The primary market is where a company creates securities and floats (sells) them to the public for the first time. If the company has never sold securities on the stock market before, then its first offering is known as an Initial Public Offering (IPO). The most important feature of the primary market is to understand that this is where you are buying securities if a company has decided to float (sell) a new parcel of securities, or if a new company wishes to raise capital by selling securities to the public.

The secondary market is where the majority of the true stock trading occurs. It is called the secondary market because this is where investor’s trade previously owned securities from other traders, not the company itself and therefore the company receives no money from these transactions. The secondary market is just as important as the primary market for a number of reasons. You may be wondering at this stage - If I am trading in the secondary market and the company is not receiving any money, why would a company have an interest in me?? - and it is a very valid question.

The reason the secondary market is so imperative is because as the share price fluctuates up and down, it affects shareholders wealth - which is their investment and money. Managers are employed to run the company on behalf of the shareholders because they have either provided the initial capital in the primary market, or now hold shares in the secondary market and have rights) which the company cannot ignore. The current share price reflects the company’s performance and future prospects as gauged by investors.

This means that if a company is performing poorly - the share price decreases because shareholders no longer want to hold the stock.  The upper management can expect criticism from investors whom still own shares and this can lead to changes at the Executive Board and CEO as shareholders have rights to vote for change in the current upper management team. Poor company performance in the secondary market also may mean that another company who is performing very well, can acquire the company in a takeover bid (another entity attempts to purchase the company).

Thus, the importance of a stock market cannot be under estimated as a fantastic tool for future investment for both companies and the individual investor whom wishes to gain for the future.

In order to create this capital a company must raise funds through a number of possible channels. The two main ways to finance additional capital is to either issue new stock or shares to the public - which is referred to as equity financing - or by choosing to adopt debt financing whereby a company must borrow money from a lending institution (a bank or similar) with the knowledge that it must pay this money back with interest in the future.

The advantage of adopting equity financing is that the company does not have to pay back the money, with interest in the future to anyone, and only owes an obligation to the shareholders who provided capital that their investment will increase in time. A company that chooses to adopt debt financing must borrow this money from a lending institution. The disadvantage with this method is that it means the company’s overall debt obligations have increased, which applies more pressure on the company to ensure that the reasoning for borrowing the money is justified. Equally, investment projects that have been financed by the debt must give a rate of return that is greater than what was originally borrowed with the added interest.