"Make it your mission to understand & invest wisely. Everyone has the potential to succeed in their search for true wealth & happiness & everyone can be successful in their pursuit of financial freedom." Contrarian Invest

Tuesday, 5 January 2016

My (brief) thought on Share buy backs!

One of my favorite JSE listed companies, Brimstone Investment Corporation (JSE:BRN) has just repurchased about 4 million of its ordinary shares at a cost of about R51.3m and at an average cost price of R12.98 per share. Are its shares undervalued? I think so. I have been keeping my eye on its share price for the past couple of months now - continuing to accumulate as much i can for the next few months. I think this BEE company has some great management with favourable long term prospects ahead.
The goal of a companies management is to maximize its return for shareholders and a share buyback generally increases shareholder value.
A share buyback, also known as a "share repurchase", is when a company buys back its shares from the marketplace. You can think of a buyback as a company investing in itself, or using its cash to buy its own shares.
The idea is fairly simple: because a company can't act as its own shareholder, repurchased shares are absorbed by the company, and the number of outstanding shares on the market is reduced. When this happens, the relative ownership stake of each investor increases because there are fewer shares, or claims on the earnings of the company.
Sometimes management may feel the market has discounted its share price too steeply so buybacks of shares is the best strategy for companies to employ when the current share price is less than the calculated fair value of the share in question.
During market downturns, such as in a recession, an opportunity may arise for companies to purchase some of their own shares and cancel them, hence reducing the overall number of shares on issue.
The effect of less shares means that the future earnings per share is likely to increase. The company share price can fall in the market for many reasons like weaker-than-expected earnings results, an accounting scandal or just a poor overall economic climate. Thus, when a company spends millions of Rands buying up its own shares, it says management believes that the market has gone too far in discounting the shares which is a positive sign.
Suppose a company repurchases one million shares at R15 per share for a total cash outlay of R15 million. Below see the change as a result of the buyback.

Before BuyBack
After BuyBack
10 million
9 million
EPS (Earnings per Share)

As you can see, the company's cash has been reduced from R20 million to R5 million. Because cash is an asset, this will lower the total assets of the company from R50 million to R35 million. This then leads to an increase in its ROA, even though earnings have not changed. Prior to the buyback, its ROA was 4% (R2 million/R50 million) but after the repurchase, ROA increases to 5.71% (R2 million/R35 million). A similar effect can be seen in the EPS number, which increases from 20 cents (R2 million/10 million shares) to 22 cents (R2 million/9 million shares).
The buyback also helps to improve the company's price-earnings ratio (P/E). The P/E ratio is one of the most well-known and often-used measures of value. When it comes to the P/E ratio, the market often thinks lower is better. Therefore, if we assume that the shares remain at R15, the P/E ratio before the buyback is 75 (R15/20 cents); after the buyback, the P/E decreases to 68 (R15/22 cents) due to the reduction in outstanding shares. In other words, fewer shares + same earnings = higher EPS!
Based on the P/E ratio as a measure of value, the company is now less expensive than it was prior to the repurchase despite the fact there was no change in earnings.
From a shareholder’s point of view, I try to make a judgement as to whether the company's offer to purchase their own shares is a sensible move by comparing their buying price to my estimate of fair value - that is, what I would pay for the share from a value investing perspective.
So depending on the price at which the offer is made, share buyback programs may be a good thing, or not-so-good thing for a value investor.

Thursday, 1 October 2015

Digging deeper with Net Net Value shares

Although local equity markets have had a pretty good run since the financial crisis in 2008, there are still examples of companies trading at low valuations and discounts that can be bought at working capital levels. Majority of them can be found in small cap shares.
My initial aim is to see if I can find any shares that are trading at such levels where the net-net working capital position (the current assets minus all liabilities) divided by the number of shares is worth more than the current share price.
It is actually a very simple calculation to make. If a company’s balance sheet has R100 million in current assets and R40 million in total liabilities (i.e., current and long-term liabilities), then the net-net working capital position is R60 million. If this company has five million shares outstanding, then the net-net working capital position per share is R12. Comparing this with a current share price of, say, R9, we can say that we have found a share that is trading at a discount to its net-net working capital.
When we buying a net-net we are getting the fixed assets, whatever they are, for free.
Net-nets are shares whose net current assets, defined as current assets after subtracting all liabilities (i.e., short and long-term liabilities)—exceed the company’s market capitalization. In other words, a “net-net” exists when working capital divided by the number of shares outstanding has a higher value than the company’s share price in the equity market.
When we find a share at these valuations, we have a situation where the liquid assets alone are worth more than we need to pay to buy the entire company. The company could be bought and put into liquidation and the investor should expect to get back more than what he or she paid for it. The fixed assets come for free, potentially raising the total returns on your investment.
Implementing this Net-net strategy as part of my overall Value investing strategy tends to consistently outperform other investing styles, especially in the long term. So, why if the results are so clearly in the favor of net-net shares, why isn’t every equity investor following this approach?
Well, one argument may be that they are most typically small caps shares. Their share prices (and market capitalization) have shrunk, in many cases by 80% or more. This makes them unattractive for large portfolio managers and unprofitable for brokerage firms to research. 
Some specific value strategies that have worked the best like the following:
  1. Low price in relation to asset value
  2. Low price in relation to earnings
  3. A significant pattern of purchases by one or more insiders (officers and directors)
  4. A significant decline in a stock’s price and Small market capitalization.

Important Characteristics to Look at in Net-Net Shares
  1. Low levels of debt. This is very important when considering investing in deep value situations. As these types of investments usually mean that the company in question is no longer profitable, the balance sheet will be under strain and the margin of safety will be eroded over time. Having little or no debt will put the company in a much stronger and more stable position. It will potentially give the company the possibility to add debt, as there should be headway to do this once the path to return to profitability is re-established. I like current assets to be made of shares, debtors and cash roughly in equal parts. If it is all made up of shares, then any valuation based on that will be much more circumspect.

  2. Positive cash flow. Any new potential investment must have positive cash flow for a number of years in its recent history. Even if all the conditions seem to be in place for a good deep value investment, if cash flow has been negative for a few years I will be very hesitant to invest. At the least, it will be very important to investigate such situations further before investing.

  3. Profitability. The company must have been profitable at some stage. The business model that the company uses must have been profitable in the past. For this reason, I tend not to invest in companies with untried track records. Avoiding companies lacking this requirement and positive cash flow will protect us from an ever-eroding margin of safety where the company may well be forced to raise further capital.

  4. Share Price. The current share price is near or at all-time lows. This indicates the sense of disappointment that the current share price has and that we may be reaching “capitulation level” where further bad news largely leaves the share price at current levels. Looking at this gives me some idea as to what levels the share price should be able to return to once the company hits higher profitability levels again.

  5. Institutional shareholder ownership. I like to see other institutional shareholders on the shareholder list to give me a sense of safety that other shareholders are able to engage with the company when this would be necessary. It is also good to check that the directors and officers of the company own shares, meaning they have “skin in the game and eat their own cooking.”

  6. A stable balance sheet. When checking the accounts of the company, I like to see a balance sheet that stays stable over a period of reporting years, with no frequent changes of accounting treatments or turnover in the accountants/auditors.

Saturday, 18 October 2014

The advantage of having a Retirement Annuity

A Retirement Annuity is aimed at people who want to create wealth for a secure retirement.

To retire comfortably, you have to save up a substantial sum of money, which will have to last you up to 35 years past the day you retire. Starting a retirement annuity (RA) fund investment is a good way to do this. And, even if you belong to a pension or provident fund through the company you work for, you can boost these savings by using an RA too. An RA is like a portable retirement fund that goes where you go.  It is not tied to your employer and is completely funded by you.

Key benefits

I love RAs because it offers a number of advantages, the biggest of which is their tax-efficiency. The government encourages us to save for retirement by offering tax incentives if we invest in a registered retirement fund. If you don’t contribute to a pension fund (company run pension scheme), you can invest 15% of your taxable income into an RA tax-free. If you do currently contribute to a pension fund, you can contribute 15% of any income that is not taken into account when calculating your pension contribution tax-free.

Another benefit is that you are not allowed any withdrawals until you retire (anytime from the age of 55), so your money is kept for its intended purpose. Your investment is also protected from creditors.

Conventional RAs had a number of drawbacks, but new-generation RAs that give you access to unit trusts as the underlying investment are one of the best savings vehicles for retirement. They come with low product fees, no penalties for surrender or discontinuation and fully transparent, negotiated adviser fees.  Furthermore, you can choose the underlying unit trusts you want to invest in and switch between funds at no extra cost. However, you will need to ensure that your RA complies with retirement fund regulations, which stipulate certain limits for assets, particularly equities, for retirement savings products.

What happens when you retire?

At retirement, a minimum of two-thirds of the capital in your RA must be invested in a pension-providing vehicle such as a living annuity or guaranteed life annuity.  This ‘transfer’ is tax free. Your annuity income is taxed at your marginal rate, which may be lower than your tax rate prior to retirement.


Current Retirement Annuity Fund Contributions
15% of taxable income from non-retirement-funding income excluding any severance benefits, or
R3 500 less current contributions to a pension fund, or
R1 750,
whichever is the greater, may be claimed as a tax deduction.

Retirement funding income vs non-retirement funding income.

As a condition of employment, certain employers contribute on behalf of its employees towards a pension or provident fund.  The contribution is normally a percentage of the gross salary, bonus, allowances and or benefits (hereinafter referred to as salary).  The salary amount subject to the pension or provident fund contribution calculation, is called the retirement funding income. 

Taxable income received from the employer that is not subject to pension or provident fund contributions, is called non-retirement funding income.  If an employee is not a member of a pension/provident fund or only contributes towards a retirement annuity fund, all taxable earnings will be defined as non-retirement funding income.

An employee whom does not contribute towards a pension or provident fund.

Example 1:
Tim is 40 years old and earns a gross salary of R150,000 per annum.
Tim’s calculation works as follows:
R150,000 per annum income x 15% = R22,500 per annum towards his RA (R1,875 per month),
R3,500 per annum (R292 per month),
R1,750 per annum  (R145 per month)
R22,500 per annum is the largest amount.  Tim can therefore deduct R22,500 per annum for tax purposes. 
The tax savings:
Let’s take a look at the 2014 tax year (1 March 2013 – 28 February 2014).
                >  Without the RA deduction Tim would pay R14,920 in tax for the year.
                >  With the full contribution towards a RA of R22,500 for the year,  
                    Tim would pay R10,870 in tax.
Tim therefore saves R4,050 in tax by contributing R22,500 towards a RA in a year.  The RA therefore effectively costs Tim R18,450 per year.

Example 2:
Sizwe earns R700,000 per annum placing him in the highest marginal tax bracket of 40%.
Sizwe’s calculation works as follows:
R700,000 per annum income x 15% = R105,000 per annum towards his RA (R8,750 per month),
R3,500 per annum (R292 per month),
R1,750 per annum (R145 per month)
R105,000 per annum is the largest amount, Sizwe can therefore deduct R105,000 per annum for tax purposes.

The tax savings:
Let’s take a look at the 2014 tax year (1 March 2013 – 28 February 2014).
                >  Without the RA deduction Sizwe would pay R197,685 in tax for the year.
                >  With the full contribution towards a RA of R105,000 for the year,
                    Sizwe would only pay R156,557 in tax.

Sizwe therefore saves R41,128 in tax by contributing R105,000 towards a RA in a year.  The RA therefore effectively costs Sizwe R63,872 per year.

But what if you belong to a pension/provident fund with zero non retirement funding income?

Admittedly the tax benefit of owning an RA is much smaller here.
Since all of his or her salary is considered to be retirement funding income, he or she does not qualify for the 15% rule.

Example 3:
Let’s work with Sizwe once more, only this time he belongs to the company’s pension/provident fund and his whole salary is subject to pension/provident fund contributions.  Sizwe contributes R52,500 towards the pension/provident fund.
The calculation is as follows:
15% of his non retirement funding income (Which is Nil)
R3, 500 less his allowable pension fund contributions (R3,500 – R52,500 = Nil)
R1, 750
R1,750 per year is the largest amount, Sizwe can therefore deduct R1,750 per year for tax purposes.
The tax savings:
Let’s take a look at the 2014 tax year (1 March 2013 – 28 February 2014).
                >  Without the RA deduction Sizwe would pay R188,765 in tax for the year.
                >  With the full contribution towards a RA of R1,750 for the year,

Sizwe would pay R188,065 in tax.

Sizwe therefore saves R700 in tax by contributing R1,750 towards a RA in a year.  The RA therefore effectively costs Sizwe R1,050 per year.

1. Any excess RA contributions may be carried forward to the following year of assessment.
2. Provident fund contributions made by an individual are not tax deductible.
3. From 1 March 2014, restrictions have been placed on the maximum allowable contributions to retirement funds.

Friday, 6 June 2014

BIG Companies, small returns


There is a catch-22 when it comes to money – the more money you have, the more problems there are with growing it.

Consider two businesses, Company A (R22.0 billion market capitalization) earns R1.4 billion per year and Company B (R1 billion market capitalization) earns R75 million per year.  

To produce a 15% return, Company A must create R210 million with their R1.4 billion in earnings.  Company B on the other hand, only needs to increase earnings by R11.25 million. 
In other words, to create the same value, Company A needs to sell almost 20 times more product than Company B.  Where Company A may have saturated a market to deal with, Company B may only be growing a foothold.

In share investing a ten-bagger is a stock that has appreciated in value 10 times. A ten-bagger is something most stock investors strive for.  A single ten-bagger can turn a mediocre portfolio into a spectacular one.  For Company B to increase ten-fold would create a R10 billion business with earnings of R750 million.  In other words, Company B even after increasing ten-fold, would not be as big as Company A is today.  Now, for Company A to become a ten-bagger, it would mean that they would need to become a R220 billion company earning R14 billion per year, bigger than most businesses in South Africa.  This company would be enormous.  

This doesn’t mean that it is impossible for Company A to produce such a return, only that it is significantly more difficult.  With all things the same, the probability of a ten-bagger by investing in Company A is significantly less than with Company B.  

Free Cash Flow

An acceptable price is not a specific number as many people believe, but a range of appropriate values. Consider a candy vending machine that generates R1000 a year in free cash flow.  If a price of R10,000 is paid, the buyer is expecting to see their money returned in 10 years.  If R15,000 is paid, then they are willing to wait 15 years.  When free cash flow is being considered as the basis for what to pay, the investor should determine how long they are willing to wait to see their money back.  Some investors are willing to wait 15 years and others are only willing to wait 10 years or less.  

The biggest mistake that investors make is not recognizing how many years they are willing to wait to see their money returned.  During the tech boom of the late 90s in America, many investors paid 60, 80 or 100 times free cash flow; not recognizing that it would take them 2 or 3 generations to see their money back (if at all).

Some even rationalized that a 40% growth rate would shorten their waiting time to an acceptable level.  This was shown to be an irrationally exuberant expectation.

By using earnings, a value of the business is determined by considering it as an ongoing entity or as a cash flow generating entity.

I would be more interested in a share when the price is falling.  Additions to a companies portfolio are better made during periods of negative returns than positive ones.  A purchase is more likely as the ratio of price to earnings falls to 12 or lower.  

Book Value

The book value of a business is its assets minus its liabilities; technically this is also the value of shareholder equity.  

Unlike the calculations used to determine the value of a business based on its cash flow over time, book value represents the value of the hard assets (and liabilities) of the business.

The book value of the aforementioned candy vending machine business is the candy vending machine assets minus its liabilities.  Assuming an asset value of R10,000 and no liabilities, the candy vending machine business has a book value of R10,000.

If the asset produces R1000 of free cash flow in the first year, the book value of the business going into the second year increases by this amount.  That is, the book value of the candy vending machine business increases from R1000 to R1100.  In businesses that produces a constant and unchanging amount of free cash flow, the book value or shareholder equity of the business will increase in a linear fashion (e.g. R1000, R1100, R1200, etc.).  In businesses that produce increasing amounts of free cash flow, the book value or shareholder equity of the business will increase geometrically (e.g. free cash increases 10% year over year; book value increases from R1000 to R1100 to R1210 to R1331, etc.).

Investing in ultra-large companies is a bad idea for individual investors.  To hope that a R100 Billion company will grow earnings at double digits over the course of the next decade (and beyond) is foolish.  Unless an investor is looking for a stable flow of dividends, investing in large companies is a waste of time.

Investing in large companies is one of the primary reasons that mutual funds (and mutual fund investors) fare so poorly over the long haul.  The combination of paying high fees to buy ultra-large, slow growing businesses ensures poor performance.

A 10-bagger (i.e. a stock that increases 10-fold) can change a poorly performing portfolio into a spectacular success.  The odds that a R100 Billion company will increase 10-fold are non-existent.

Smaller companies (i.e. < R5B market capitalization) not only offer superior returns, but their price fluctuates far more dramatically which provides greater opportunities to invest at an attractive price.  The best way to ensure satisfactory returns is to invest in “tiny” companies with clean balance sheets and proven growth.  

The High Price of Diversification

Another often promoted concept is diversification.  Mutual funds and financial planners have pounded this concept into the mind of the public for years.

In 2008/09 market slump businesses on the JSE across every sector were decimated as prices all came down to earth.  

Diversification offers no protection from downside risk and virtually guarantees poor results. The great irony here is that my portfolio of about a half a dozen shares has performed better than the wildly diversified market indexes in the last two stock market meltdowns of 1999/2000 & 2008/09.  

Thursday, 3 April 2014

Investing - The best way to grow your money!

Investing in the stock market is surely by far the best way to grow your money but it can either be a very inviting or intimidating experience to new investors. It was exciting to me when i started my journey into investing on the stock market 13 years ago. I enjoy working with numbers alot which is probably why i also love Accounting so much. After all, Accounting is the language of business. I was always interested in investing & i’m glad I took the plunge into investing back then. I liked the idea that i could own a small share of a business that i liked & share in their profitsMany years later those investments have paid off handsomely.

After reading copious amounts of literature & doing some trading courses on investingI set up an automatic debit order. I bought my very first ETF (Exchange Traded Funds) in 2001. (more about ETF's later in the blog post) . 

It was the Satrix40 ETF. Since inception its yielded a annualized return of 17%.  - My investment horizon is typically five to ten years, and my investment goals are split – between having some stable cash inflow and at the same time build a strong cash base.  I am investing for my early retirement. I plan to 'retire' at 40 :)

The market fluctuates on a daily basis & very difficult to predict, but because i have a long term view i don't stress about the daily movements of the shares or ETF's  i own. I know in the long run i'll benefit from my Rand Cost Averaging strategy & expose myself to less risk. I invest in businesses that have good management teams, competitive advantages in their industries, clean balance sheets, high returns on non-leveraged equity, steady earnings growth and long histories of increasing their dividend every year.  These businesses are easy to understand and the products they sell are recognize brands sold worldwide and don’t change all that much.
It’s best you start investing early. Be consistent. As you know, time is a non redeemable commodity and therefore time in the market can be most beneficial to your portfolio.

In this blog post I share some insights on the bare basics to get an investment portfolio going of your own. I can't stress enough of the vital importance of starting investing as soon and as early as you possibly can! 

So lets start with the basics...

What is a share?
If you own a share, you own a portion of a company. In the same way you can see your ownership of a company as a slice of pie, cut out of a bigger pie. Someone who owns one or more shares is called a shareholder. Shareholders may receive cash flows (dividends) if a company’s board of directors declare that the company has performed well and has enough profit to distribute to its shareholders.
A share in the company gives you the right to vote on decisions affecting the company. You can also call a share, ‘equity’ or ‘stock’.

What is the share price?
The share price is the price at which a particular share can be bought or sold. The share price is determined by the supply and demand for a particular company’s shares.

Factors affecting the share price
When you have more buyers than sellers for a particular company’s shares, share prices usually Rise because these shares are in demand.

When you have more sellers than buyers for a particular company’s shares, share prices usually Fall because there are more of these shares available. 

If a company is very profitable, a share in that company will become more valuable because more people think that it is a good investment. Factors such as economic and political events also influence share prices.

How do I know which company to invest in?
Do research on the stock market through regular reading of financial literature, attending investment courses and seeking a qualified expert’s (like a stockbroker) advice.
This will enable you to make educated decisions on which companies to invest in.

Determine how much risk you want to take on, how much return (profit) you expect and which investment products meet your needs. Consult a stockbroker if you need additional advice. Try to be committed to this  investment objective. Always remember that you should  invest for the long run, e.g. have a 5 year minimum investment objective.

Determine how long you are prepared to wait for a return on this investment and be patient. If a share does not perform you may need  to review your strategy.  Invest with money that you do not need in the short run and can afford to lose, i.e. your disposable income after all your day to day needs have been taken care of.  Although investing allows you to make a good profit you should also be aware of the risk of losing money in the short run.

Are there different types of shares and investment products?
There are various types of shares and investment products to suit different individual needs, for example conservative or “safe” shares versus riskier shares. A list of basic share investment products is included below:

·         Ordinary shares
·         B-Ordinary shares
·         N-Ordinary shares
·         Preference shares
·         Exchange Traded Funds

What is risk?
Risk is the possibility of losing part or all of your initial investment or the likelihood of making a profit that is less than what you anticipated.

Investing on the stock market is riskier than some other investments. The reason for this is that share prices rise and fall all the time as economic and market forces change.

However, the higher risk involved also means that you have an opportunity to make a greater profit. Usually, higher risk means a higher return (profit).

It is important to realize that share trading normally does not make you rich overnight, but that it should be treated as a long term investment.

Can I minimize the risk of my investment?
You can minimize your investment risk by diversifying your investment.
To ‘diversify’ means to invest in a variety of different investments. To protect your investment you should avoid putting all your ‘eggs’ in one ‘basket’. When one company’s share price doesn’t perform well, you can still benefit when your other company’s share price does well.

Consider choosing your investments from a variety of sectors, companies and investment products.

To help you with this decision consider regularly reading financial literature, attending investment courses and seeking a qualified expert’s advice.

Is it difficult to manage my investment portfolio?
Certain investment products require little or no management. However, always be sure to be aware of how your investments are performing. Stockbrokers also offer different types of services to help you manage your investments:

– all investment decisions are made by the stockbroker without checking with you, but is made inline with an objective.

– all investment decisions are made by you, after the stockbroker has given the necessary advice.
Inexperienced investors and even seasoned  investors can look at a single investment product that offers you exposure to a wide variety or ‘basket’ of shares, bonds and even gold. This product is known as an Exchange Traded Fund (ETF) .
ETFs are fairly easy to do research on (as opposed to researching numerous companies), offer lower costs and are able to spread your risk across a variety of shares, bonds and gold.
However, Exchange Traded Funds do not offer you direct voting rights, as is the case of with ordinary shares. You still however gain the benefit of receiving dividends in some instances. 

Do I need a lot of money to start investing?
You don’t need a lot of money to start investing on the stock market as there are many investment products available to suit everyone’s pocket.
Some products, like…

Exchange Traded Funds (ETFs),
ETFs offer investment plans where a monthly debit order (minimum of R300) or once-off lump sum (minimum of R1000) investment can be made.
Stockbrokers don’t always require a minimum investment amount. With online share trading now widely available, you are able to invest any amount on the stock market via the internet.

However, be aware that stockbrokers do charge fees and that it makes sense to invest an amount where the costs that you pay aren’t bigger than the amount you’re investing.

How do I gain access to the stock market?
To buy or sell shares on the Johannesburg Stock Exchange (JSE) you need to open a brokerage account with a stockbroker.

How to open a brokerage account
Buying and selling ETFs does not require a brokerage account. You can contact the ETF provider directly to invest in these investment products. However, owning a brokerage account allows you to invest in all kinds of investment products, not only ETFs. Some things to consider Invest an amount that makes sense in comparison to the amount of brokerage fees that you’ll be paying.

Plan your investment objective, exercise self-discipline (commit to your long term investment strategy) and remember to monitor your investment performance.
Steer away from borrowing money to invest, especially if you are not sure whether the profit you will be making on the investment will be able to repay your interest on the loan and your loan over time.

Exercise patience and do not become emotionally attached to your investments. Some days your investment will make money and other days it will lose money. Ensure that you try to diversify your portfolio.

I hope this post has helped you and given you some insight on how to begin your journey to investing on the stock market.

Happy Investing :)

Thursday, 30 January 2014

Making that first Million Rand...

All wealthy people are investors in one sense or another. If you want financial independence, you have to acquire the habit of investing and managing your investments. The average South African doesn't even earn a million over ten years – and that's before paying all the bills. Even the average person in the top decile (top tenth) has to work for four years to make a million after tax – again, before deducting the cost of living. If you're in the ninth decile (ie, better off than 80% of South Africans but not in the top 10%) it will typically take you over ten years to earn a million rand after deductions. After buying groceries, paying the mortgage and putting petrol in the car most people don't have a lot left over. So to accumulate a million rand, in cash, unencumbered, yours to do what you like with, is not a trivial matter for most South Africans.

You have probably heard the expression that “the first million is the hardest”. This has nothing to do with learning how to make money and somehow mastering it after the first million. In fact, it is equally hard to save the first R1 million as it is to save the first R100,000
On the other hand, we never say that the first R100 or the first R1000 is the hardest. Why is this?
It has to do with Benford’s law. The simplest explanation I can think of is that the increase from R1m to R2m represents an increase of 100%. Conversely, the increase from R2m to R3m is 50%, R3m to R4m is 33%, …. and 9 to 10 is 11.1%

Of course, if you already have a million, it's a lot easier to make another million. All you need is an investment with a return of around 10% per annum and seven years later your one million has turned into two million (provided you haven't been taxed to death along the way). Even better, find an investment that gives you 15% per annum and your money will double in less than 5 years. Money makes money.

But that first million, that's the challenge. If you put away R4 000 a month and achieve 10% annual compound growth, it takes over eleven years of disciplined saving to end up with a million. And where are the savings accounts offering 10%? A rate of half that would be more realistic, especially after tax. At a net 5% per annum it takes over fourteen years. And how many people can afford to save R4 000 a month anyway? If you save R2 000 a month it's going to take you 23 years, and R1 000 a month… more than three decades.
So what's the alternative to this demoralising scenario?

Rate of Return

If you want to make a million by saving and investing, you need to understand that your rate of return is the key factor. The difference between a return of 7% per year and 15% per year is a decade – it takes 27.5 years to turn R1 000 a month into a million at 7% a year, but only 17.5 years at 15% per year. (I'm sure you'd like to make your first million in less than 17.5 years, but we'll get back to that in a moment.) As I said above, if you can afford R2 000 a month and your rate of return is 5% per year, it will take you nearly 23 years to make a million.

The long-term stock market rate of return is between 14% and 16% (it varies depending on the exact time period used). This is  based on the market average; by definition, therefore, on a consistent basis, half of all listed shares are doing better than this – some a lot better. But even the market rate of return improves things considerably. At the stock market average, instead of waiting 23 years, you can turn R2 000 a month into a million almost ten years sooner.
My point is that, compared to conventional saving, if all you achieve is the average market return, investing in shares is likely to halve the time it takes you to achieve your financial objectives (roughly speaking).

Unit trusts capitalise on the power of long-term stock market returns. As at May 2012, for example, the average annual return of the top 50 equity unit trusts was around 20% per year over 10 years, compared to a market average of around 14% per year. And listen to this – at 20% per year your money doubles in less than four years!
The good news is that you can do even better than this. Much better, in fact. As a private investor, you can exploit opportunities that are too small for fund managers. In the words of Warren Buffet, "It's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that."
At a return of 50% per annum you can turn R2 000 a month into a million in less than seven years. Or R4 000 a month into a million in less than five years. Or R1 million into R10 million in less than six years.

Keeping it Real

Let's assume you can't achieve 50% per annum! After all, Warren Buffett is an exceptional investor. Let's assume, rather, that as private investors we can do just slightly better than the market average – that we can achieve 20% per year. This is a realistic objective.

Now I'd like to be able to show you a way to make that first million in ten minutes or a couple of years, but the reality is that it takes time. Consider this – if you put R2 000 under you mattress every month, after 12 years you'll have R288 000 in your bed. You'll also have a very uncomfortable lump under your back, but that's a different issue. R288 000 is a far cry from a million. So although 12 years seems like a long time, it's actually quite remarkable that by adding an investment return of 20% per year your savings of R288 000 will turn into a million over the same period.

What can you do to reduce the 12 years? Obviously saving more money every month would help, but if you can't afford more than R2 000 a month, the best thing you can do is improve the rate of return. At a return of 25% per year you'll shave two years off the program. Get it up to 30% per year and you can do it in nine years (having put away only R216 000).
I'm not going to lie to you – if you don't have any capital, it's really not that easy to make that first million in much under eight years (not unless you can save R5 000 a month or more, which is not realistic for most people). Anybody who tells you otherwise is either lying or has been exceptionally lucky in the past.
The great news is that, once you have some capital, it gets much easier. Once you've got that first million, you're on your way. After that is really is feasible to double your capital every three to four years.

Finding the Return

The only place you can consistently get returns of around 15% per annum is the stock market. (Some people will argue that property can also do this for, but that's only true when property is debt-financed, which brings its own set of risks and challenges.)
Before you get the wrong idea, let me emphasize that stock market returns fluctuate a great deal. Most years, on average, the market goes up – sometimes a little, sometimes a lot – but every few years the market actually goes down. So when I say that the market can consistently give you a return of 15% per year I do not mean that you can expect this if you go into the market just for one year! However, you can expect around 15% per year – on average– if you invest in the stock market over the long haul (at least five years, preferably ten or more).

To get the 20% (or better) return that we want we have to select above-average shares. Talking simplistically, the market average (that 15% per year I keep mentioning) includes the performance of all shares – the half that are below average and the half that are above average. If you invest predominantly in above-average shares it stands to reason that you'll get above-average performance. And the beauty is – simplistically speaking – that, by definition, one out of every two shares is above average!
How do you find above average shares? The answer is simple – by identifying above average businesses.
Never forget that shares represent ownership in companies. In the long run, the share price of a company can only keep going up at 20% per year (or more) if the underlying business grows at 20% a year (or more). There are certainly times in the stock market when sentiment causes a disconnect between share price movement and business performance, but this kind of disconnect is always relatively short-term. Over the long haul, any company that doesn't grow its profits will suffer a falling share price.
Obviously, to identify above average companies you need to know something about their businesses. You need to know what they do and whether management have been successful at growing sales and profits in the past. You need reason to believe they can keep growing sales and profits in the future. And to do this, you need a way to access the right information quickly and efficiently.

A Quick Summary

This post has a lot of per year' figures. You might be thinking – 16% a year? 20% a year? Is it really such a big issue?
The answer is a resounding Yes. Seemingly small changes in your annual rate of return are really important – don't make the mistake of thinking that a few percent here or there makes no difference. For example, R1 000 a month earning 16% a year turns into R1.6 million over 20 years. Not bad. But at 20% a year it turns into almost R2.7 million! That seemingly small difference means two-thirds more capital at the end of the day.
Couple this with the fact that, as a private investor, you can do slightly better than the market average and you have a recipe for success. All you need are the right tools for finding those shares that will be in the front half of the field.

Happy Investing :)