Choosing shares to buy

If you want to choose your own shares, a good place to start is the S&P/ASX 50. This is a list of Australia's top 50 companies — known as 'blue chip' companies.

These are well-established, stable companies that suit an investor looking for steady returns with less risk.

'Speculative companies' do not have a long market history, and are not in Australia's top 100 companies. You may get a large return — or a large loss.

These suit a more experienced investor prepared to risk capital in the hope of getting higher returns.

Some companies listed on Australian exchanges have business operations or assets outside Australia. It pays to check where a company operates, so you can assess the risk of investing. Consider issues like language, distance and currency. There could be different standards of regulation, risk management, internal controls or auditing. Your investment may have less protection than under Australian law.

More established markets include the United States, Hong Kong, Japan and New Zealand. Less established markets include other parts of Asia and the Pacific, Central and South America, Africa, Eastern Europe and The Middle East. Companies operating in these areas are known as 'emerging market companies'.

Work out what you want from your shares. Do you want regular income or just capital growth?

If you want regular income, consider companies with a track record of paying high dividends. These tend to be larger companies on the Australian Securities Exchange (ASX).

Smaller companies often focus on growth. So they are more likely to reinvest profits in the business, rather than paying dividends to shareholders.

Start with an industry or business sector you know. This gives you a better chance of recognising if a company is strong or weak.

Look at the ASX list of companies or Cboe for a breakdown of sectors.

Make a list of companies you're interested in. Then check:

• What is the company's position in the market?
• What competition does it face, and how does it compare to others in the sector?
• Are the goods and services it provides likely to be in demand in years to come?
• Are there opportunities for the company to grow in the future?

Each sector of the market has its own pros and cons. Generally:

• Finance — Banks and other financial institutions usually offer steady income through high dividends.
• Resources — Mining companies offer potential for high capital growth, but tend not to give high dividends. This sector can be highly cyclical. It does well when the international economy is healthy, but badly when not.
• Consumer — Retailers offer medium-sized dividends. This sector tends to move up and down with the Australian economy.
• International — Gives you access to larger markets outside Australia. Enables investment in other sectors or asset classes, giving broader diversification. Potential for higher returns at times, along with greater exposure to volatility.

To decide if investing in Australian shares is right for you, consider the following:

Pros:

• Potential capital gains from owning an asset that can grow in value over time.
• Potential income from dividends.
• Lower tax rates on long-term capital gains.

Cons:

• Company share prices can fall dramatically, even to zero.
• If a company goes broke, you may not get your money back.
• The value of your shares will go up and down from month to month, and the dividend may vary.

If you're thinking about buying international shares, consider these pros and cons.

Pros:

• You can invest in companies or industries not represented, or under-represented, in the Australian share market.
• Enables geographic diversification, so a slow-down in one market may have less impact on your portfolio.

Cons:

• Greater volatility from movements in currency exchange rates.
• Regulatory or political changes could impact your investments.
• Delay in trades and information due to markets operating in different time zones.
• Different tax treatment on income from international investments may mean you need professional tax advice.

Start with the company's annual report. Get the current and last year's reports from their website so you can compare progress.

An annual report is like a report card for a business. It tells you:

• core business activities
• future prospects
• whether the company is making a profit or loss
• company strategy

Key things to look for in annual reports are:

• A proven track record — This year, has the company done what it said it was going to do in last year's report? If its strategy has changed, this could affect performance. When looking at how activities and earnings are reported, be aware that many companies have been significantly impacted by COVID-19.
• Valuable strategic acquisitions — If they are expanding by buying other businesses, will this add value? A new acquisition may give access to markets, technologies or products. This could affect the share price.
• Research gets results — Has spending on research and development led to something tangible? For example, the sale of new software or production of a high tech product.
• Profit or a good reason for no profit — Did the company make a profit or loss? If a loss, why? Many companies do not make a profit during their start-up phase. If this is the case, when does it expect to make a profit?
• Cash to pay for operating costs — Look at the cash flow. Has the company used its own money or borrowed funds? Borrowing includes loans or issuing convertible notes (debt securities that convert to shares). If it has issued more shares, this could dilute existing investor shareholdings.
• Enough cash to last — Is it generating revenue from its operations? If not, will it have enough cash to last until it does generate revenue? Or will it need to borrow money or raise more funds from investors?

Stay current by subscribing to alerts from:

• ASIC — Set up a free company alert to get an email every time a company lodges information. This includes takeovers, buybacks and floats.
• ASX — Check the prices section of the ASX website for company information and announcements.
• Business and finance media — Set online alerts for coverage of company activities.
• Company websites — Set up watch lists to monitor the performance of shares you are interested in.

If a company is issuing shares for the first time, get its prospectus. See how to buy and sell shares for tips on what to look for.

Your broker may give you access to research reports on companies of interest.

Comparing a company to its competitors is one way of assessing its value. No single measure will give you the answer, so use a range of sources.

Here are some basic comparisons you can make:

• Earnings per share (EPS) — The part of a company's profit allocated to each share. The higher the EPS, the more a share could be worth. To get the EPS, see the company's website or annual report, or the ASX website.
• Price-earnings ratio (P/E) — A way of working out if the price of a share is over or under-valued compared to its competitors. In general, the lower the ratio, the better. A low ratio could also mean the market expects earnings to be lower in future. To work out the P/E ratio, divide the share price by the EPS.
  During times of higher market volatility, such as COVID-19, past earnings may not be indicative of future earnings. It can also be more difficult to forecast future earnings. So the P/E ratio may not be a reliable indicator. Look at other metrics.
• Dividend yield (%) — A company pays dividends from profits, so this can show how it's performing. Generally, a high yield is good. But it's not good if dividends come from borrowings. To work out the yield, divide the dividend per share by the share price.