If you’re going to be a stock investor, you’re going to need to know the language of Wall Street. While there are textbooks upon textbooks that have been written on the matter, you can get a good start right here, by soaking up a few key terms about stocks and investing.
Let’s start with a few of the fundamentals.
The Real Deal on Revenues
Revenues are what a company takes in on sales of its products or services. (In fact, sometimes revenues are referred to as sales.)
But it’s not enough to have a lot of revenues. Companies have to pay for plenty of expenses, like employee salaries, supplies, raw materials, advertising, and so on. After taking care of all of these costs, companies figure their pre-tax income. That’s right ‘ corporations have to pay taxes too, so once the tax bill is paid, they can determine their bottom line ‘ their net income.
Investors look to a company’s net income to determine how profitable it is. Simply looking at a company’s net income for a year is one way to check, but you can also consider its profit margin. This is the company’s net income divided by its revenues, and is expressed as a percentage. When you compare similar companies, you can look at the profit margins of both to see which company is able to generate higher profits from each dollar of sales.
Learnings About Earnings
Investors also like to look at earnings per share (abbreviated EPS). To calculate EPS, divide a company’s net income after taxes by the number of outstanding shares of stock. These are shares of the company’s stock that have been issued and are currently held by investors.
Some companies, particularly larger, established companies, give investors a share of their earnings on a regular basis. These payouts are known as dividends. Divide the company’s indicated dividend (the payments that are expected for the next year) by its current stock price, and the result is the dividend yield.
A dividend adds to the total return you might receive from investing in a stock. The other component of return comes from capital appreciation ‘ the increase in the price of the stock. Total return is usually calculated on an annualized basis, which considers the expected change for each full year in the period.
If you’re investing in growth companies, you want to be able to identify how quickly companies are increasing their revenues, pre-tax profit and earnings per share. You can often find the growth rates for these and other financial figures calculated for you in research reports and Web sites. Growth rates are recorded on a quarter-to-quarter and year-to-year basis, as well as for multi-year periods.
On the Books
One way that investors try to figure out how much a company is worth is to look at the book value. A company’s book value is its total assets less its liabilities, preferred stock and intangible assets ‘ in other words, the value of the company if it were liquidated and all debts and bills paid. This figure is often divided by the number of shares outstanding and reported as book value per share.
Senior employees of a company, as well as members of its board of directors, are known as insiders since they’re often privy to confidential information. But if these insiders own a significant number of shares of the company’s stock, instead of merely collecting a paycheck, they might be more motivated to act in the interest of shareholders. That’s why outside investors sometimes check the level of insider ownership of the company’s stock. Higher levels of insider ownership can be a positive factor when examining a stock.
The Importance of Institutional Investors
The level of ownership by institutional investors of a particular stock is another issue to consider. Institutional investors are large shareholders like pension funds, mutual funds, and large money management firms, and their interest in a stock can be important in supporting the rise of that stock’s price. But too much institutional ownership can be a negative, since heavy selling by institutions can contribute to a stock’s downfall during tough times.
One way to measure the risk of investing in a stock is to look at the stock’s beta. Beta measures the tendency of the stock to move up or down in price compared to the overall market (usually the S&P 500). A beta greater than one means that the stock is more volatile than the market, while a beta below one is less volatile.
Companies are often classified by size according to their market capitalization (or market cap), figured by multiplying the number of outstanding shares by the current stock price. A small-cap stock has a capitalization of less than $1 billion, while a large-cap stock has a market cap of more than $5 billion (with mid-cap stocks in between).
There are plenty more terms and phrases you’ll encounter as you start investing, but master these basics and you’ll be talking like an investor in no time.