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This is a short Intro to the Stock Market article describing the most important, in my opinion, terms to know when deciding to get into the game for big boys and girls.
There are many terms you will come across if you get serious about investing. To keep this from being too long and humdrum, we’ll go over 5 terms each in these three categories:
- Asset Metrics
Here we goooooooo…
The need-to-know terms.
Portfolio and Assets- Your portfolio is made up of all of your investments. It is usually referred to as your ‘investment portfolio.’ Investments are also called assets and can include your properties, company shares, cash, etc… and a strategy for successful investing is asset accumulation.
Diversification- You will run into this one a lot. Diversification is all about implementing variety for risk management. Variety in your asset allocation is the key here and different investing strategies suggest different levels of diversification. Ex:
If you invest all of your money in 1 stock and that stock goes bust- you’re dead.
If you diversify and split your money into 5 different stocks and 1 goes bust; you still have the other 4 to help offset the loss.
Index- An index is made up of stocks related to what the index is about. A popular index used to gauge the stock market as a whole is the S&P 500 and is comprised of the 500 most influential and large companies in the market.
The Russell indices (or indexes) are also popular. The Russell 1000 is aggregate of the top 1000 large-cap (we go over large-cap below) companies on the stock market, the Russell 2000 is made up of the bottom 2000 small-cap companies and the Russell 3000 is the combination of the two.
Indices are great for gauging the performance of and the confidence in the stock market and there are indices for any and everything.
Dividends- When you buy a company’s stock, the company gets your money and you get a share of the company. This means that public companies, companies you can buy stock from, like to have people buy their stocks. Dividends are little incentives companies put in place to make people want to buy their stock just a little more.
Dividends are regular payments made to shareholders. They can be a specific per share amount or a percentage of the market value. You can keep your dividends or re-invest them.
Bear vs. Bull- The market cycles randomly between the two.
A bear market is an overall decreasing market- one with less confidence. A bear investor thinks a certain stock or asset will decrease in market value and will usually take a short position.
A bull market is the opposite- an overall increasing market with more confidence. A bull investor will buy an asset in anticipation of an increase in market value.
Make it easy. Bulls rush and bears hibernate.
These terms are asset related and are essential to know to help make better decisions if you are a beginning investor.
Liquidity- Liquidity has to so with your ability to turn your asset(s) into cash immediately.
Ex: So Tony wants his money and he wants it now. You have no cash but you have assets:
- You have all real estate properties. These you cannot sell immediately and have to wait for a buyer and go through tons of paperwork. These are not liquid. Tony does not get his money now. You are dead.
- You have all stocks and bonds. These you sell immediately. They are liquid and you receive cash immediately. Tony gets his money and you are alive and decide not to deal with loan shark gangsters anymore.
IPO- Initial public offering. This is the time when a company first offers shares to the public.
The idea usually is that the IPO stock will be a low price and the company will have lots of room to grow and become a great company, so investing in an IPO should give you a better chance for growth.
But as you know, higher reward is generally proportional to higher risk so don’t have only IPOs in your portfolio and don’t blindly invest in an IPO.
Blue Chip- Blue chip stocks are large, reliable, and generally profitable stocks. The Dow Jones Industrial Average is an index that follows only blue-chip stocks.
Prospectus (P/E, etc…)- This is a document that all publicly traded companies are required to provide by the SEC (the stock market rule makers).
This is where you will find information about the company and should be a part of your due diligence if you are considering investing in a stock.
Below is a link to a site describing everything that must be included in a company’s prospectus:
Market Cap- Short for market capitalization, market cap is used as another way to help investors decide if a company stock fit’s their strategy.
A company’s market cap = it’s amount of shares offered x the price of the stock. If a company has 30,000,000 shares and each share is valued at $100. then the market cap of the company is $3 billion.
Depending on the market cap of a company, a company can be rated as a large cap (>$10 billion), small cap (<$2 billion), mid cap (>$2 billion and <$10 billion), mega cap, micro cap and even nano cap.
Large cap companies are blue-chip stocks and small cap companies have a higher room for growth.
For more on market capitalization check out investopedia’s article here
Wow, way to make this post engaging
Sarcasm, by Doug
These are math associated terms that you might use to help you to judge whether you want to add an asset to your portfolio or not.
Standard deviation- This number will describe the amount of variance in the percent gains/losses of the market value of an asset, aka big number = historically more volatile or small number = follows a linear growth/loss path pretty well
Sharpe ratio- A little complicated but is defined by Fidelity (who uses a 3 year sharpe) as:
3-Year Sharpe Ratio is a measure of adjusted performance. It is calculated by dividing the fund’s excess returns (fund’s average monthly returns minus the average monthly return of the Salomon Smith Barney 3-Month T-Bill Index) by the standard deviation of those returns.
So a higher number means that the fund is a winner, historically higher reward and lower risk; and if a number is lower it is not worth it, historically lower reward relative to a higher risk.
Beta- A metric proportionally showcasing the volatility of a asset compared to the volatility of the stock market as a whole.
If a stock’s beta is 1, it has historically matched the waxing and waning of the stock market.
If it is lower, it has been more steady while the market was moving around.
If it is higher, it has been out-performing the stock market in increases as well as decreases.
EPS- EPS or earnings per share is a measure of how much a company has profited as it relates to each share it has.
It is calculated by taking the net income, subtracting dividends (if they have them (if they don’t, just divide the net income by the shares)) and dividing that number by the shares they have.
The EPS is also used in figuring out the P/E ratio.
P/E ratio- The price to earnings ratio. The P/E ratio will tell you how much money each share made in relation to how much each share costs to purchase.
A P/E ratio is figured out by dividing the price of a stock by the EPS. Signifying, presumably, the lower the number the better- but always use it in conjunction with your other metrics.
Simplified: A higher P/E ratio means that you spend more for less and a lower number means that you spend less for more.
All of these metrics are historical and have no predictive and/or crystal ball powers. Aliens could come and enslave us all and all of your investments would cease to exist. All I’m saying is, these metrics help but they do not predict the future.
Hope this was helpful!
Get started in the stock market now and you will thank yourself later!
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