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The world of investment has a language of its own. For beginners, wonky terms like EBITDA and P/E ratio can feel off-putting. But fear not: even the most obscure sounding terminology can usually be explained by core concepts and common sense. Besides, you should never let a little jargon scare you from smart investing.
If you’re getting into investment, this post is for you. Below is a guide to the most essential investment terms and what they mean – get these down and you’ll be talking shop like a seasoned professional.
How you divide your portfolio by different types of assets (typically stocks, bonds and cash). A good asset allocation balances your risk tolerance (see below), your financial goals, and whether you’re looking to make short or long-term investments.
Spreading your investments across different types of assets, industries, or geographies in order to minimize the impact of any single investment going sour. For example, you buy gold to “diversify” a stock-heavy portfolio.
How willing are you to endure a sudden price drop or crash in value? That’s your risk tolerance. Investors with high risk tolerance are usually seeking higher returns. Retirees usually have low risk tolerance, young investors the opposite.
Read more: Five Investment Risks Every Investor Should Know & How to Minimize Them.
The household names and established companies that are considered stable, relatively lower risk stocks are called blue chips. Think Coca-Cola, Apple, Walmart, and so on.
Divide a company’s profit by the number of outstanding shares and that’s how much money the company makes per share, or EPS. Higher EPS often signals higher profitability.
This is a common way to assess a company’s stock. The ratio itself compares a company's current share price (P) with its earnings per share (EPS). A high P/E ratio could mean the stock is overvalued. Compare P/E ratios of similar companies in the same industry to see which stock is a relatively better value.
This is the total value of a company’s outstanding shares. It’s often referred to as “market cap.” To calculate it, simply multiply the share price by the number of shares. When you hear “small-cap” or “large-cap,” it’s referring to whether the company has a small or large market capitalization.
When a company turns a profit, it may pay back a portion of those profits back to shareholders, either in cash or additional shares. This reward for holding shares is called a dividend.
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This is a percentage that refers to how much a company pays in dividends each year, relative to its stock price. For example, a $100 stock that pays a $2 dividend for every share held has a 2% dividend yield.
This tells you how much you’ll pay each year to be invested in a fund, like a mutual fund or an ETF. It’s expressed as a percent of your investments. When comparing mutual funds or ETFs, check to see which have lower expense ratios. Lower expense ratios imply that more of your money is going to investing and less to paying the fund manager.
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Also known as “par value.” This is how much you will be paid back when the bond matures, regardless of how much you actually paid for the bond, as sometimes you buy a bond for more or less than its face value.
The date the bond’s face value is paid to the investor.
The total return you can expect to earn if you hold a bond until it matures. It’s what you would earn from all coupon payments (see below) plus the original principal, assuming you re-invest each coupon payment and earn the same rate.
A regular payment made to bondholders for holding the bond, which is a type of interest payment when it comes to traditional bonds or a profit rate payment for sukuk.
The coupon rate is the annual interest rate or profit rate, expressed as a percentage of the bond or sukuk’s face value.
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A percentage that measures the gain or loss generated on an investment, relative to the amount invested. If you earned $100 on a $1000 investment, your ROI is 10%.
A percentage that measures how efficiently a company generates profits. To calculate it, you divide the company’s net income by shareholder equity.
In other words, you’re seeing how much profit the company generates (net income) with the money shareholders have invested (shareholder equity).
A higher ROE means a company is good at generating income from the money being put in by shareholders.
A percentage that measures how efficiently a company is using its assets to generate profits. To calculate it, you divide Net Income by Total Assets. A higher ROA means a company is more effective at using its assets to turn a profit.
The sum of all gains made on an investment – everything from the price increase, dividends, coupon payments. Add them all and you have the total return.
The average rate of return per year over a specific period. It gives a quick snapshot of an investment’s performance without providing details about volatility or fluctuations in price or value.
A common measure of risk, beta measures a stock’s volatility relative to the volatility of the overall market. A Beta of greater than 1 means that the stock is more volatile than the market, less than 1 means it is less volatile than the market. For example, a beta of 1.5 means the stock is expected to swing in price 50% more than the market swings in price.
This compares a company’s market value (its stock price) to its book value (the value of its assets minus its liabilities).
When the ratio is less than 1, it means investors are paying less than the value of the company’s net assets, suggesting the stock might be undervalued.
Over 1 means the market is paying a premium, perhaps because it has strong earnings potential, or it is simply overvalued.
This gauges how much a company is relying on debt to finance its business as opposed to its own resources, like revenues earned on sales.
To calculate it, you divide total debt by total shareholder equity. Lower D/E ratios often mean a company is less risky, but the ratios vary by industry.
How much cash a company has on hand after it has paid for operating expenses and capital expenditures (e.g. payments for equipment or property).
Positive FCF means the company is generating more cash than it needs to run and grow the business, a good sign.
Refers to “Earnings Before Interest, Taxes, Depreciation, and Amortization”. This is a way to measure how much profit a company earns from its core activities.
You’re essentially removing non-operating factors (like interest payments and taxes) to get a look at how much cash flow is generated by the actual core business. This can help you compare companies in the same industry. Higher EBITDA can point to a better operating performance.
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Disclamer:
This post is for educational purposes only, and does not constitute investment advice or a solicitation to take any financial action. It should not be relied upon when making investment or financing decisions.
