The Fundamentals of Stock Market- Must Know Terms
Here are the few key financial terms that a stock market investor must know. Although the list is long, it will be worth to know these terms to get a good grasp on the fundamentals. Here it goes:
Promoter’s shares: – The company shares that are owned by the promoters i.e. the owners of the company is called Promoters shares. The public cannot own these shares.
Outstanding shares: The company’s shares that are owned by all its shareholders, including share blocks held by institutional investors and restricted shares owned by the company’s officers and insiders.
Public (retail investors), foreign institutional investors (FII), Domestic institutional investors (DII), mutual funds etc. can own outstanding shares.
Market Capitalization: – Market Cap or Market capitalization refers to the total market value of a company’s outstanding shares. It is calculated by multiplying a company’s shares outstanding by the current market price of one share. The investment community uses this figure to determine a company’s size, as opposed to using sales or total asset figures. In general, market capitalization is the market value of company outstanding shares.
Market Capitalization = No of outstanding shares * share value of each stock
Book value: – It is the ratio of total value of company assets to the no of shares. In general, this is the value which the shareholders will get if the company is liquidated. Hence, it is always preferred to buy a stock with high book value compared to the current share price.
Book Value = [Total assets – Intangible assets (patents, goodwill..) – liabilities]
Earnings Per Share (EPS): This is one of the key ratios and is really important to understand before we study other ratios. EPS is the profit that a company has made over the last year divided by how many shares are on the market. Preferred shares are not included while calculating EPS. In general, Money earned per outstanding shares.
Earnings Per Share (EPS) = (Net income – dividends from preferred stock)/(Total outstanding shares)
From the perspective of an investor, it is always better to invest in a company with higher EPS as it means that the company is generating greater profits.
Price to Earnings Ratio (P/E): The Price to Earnings ratio is one of the most widely used financial ratio analysis among the investors for a very long time. A high P/E ratio generally shows that the investor is paying more for the share. As a thumb rule, a low P/E ratio is preferred while buying a stock, but the definition of ‘low’ varies from industries to industries. So, different sectors (Ex Automobile, Banks etc) have different P/E ratios for the companies in their sector, and comparing the P/E ratio of the company of one sector with P/E ratio of the company of another sector will be insignificant. However, you can use the P/E ratio to compare the companies in the same sector, preferring one with low P/E. The P/E ratio is calculated using this formula:
Price to Earnings Ratio= (Price Per Share) / ( Earnings Per Share)
It’s easier to find the find the price of the share as you can find it from the current closing stock price. For the earning per share, we can have either trailing EPS (earnings per share based on the past 12 months) or Forward EPS (Estimated basic earnings per share based on a forward 12-month projection. It’s easier to find the trailing EPS as we already have the result of the past 12 month’s performance of the company.
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Price to Book Ratio (P/B): Price to Book Ratio (P/B) is calculated by dividing the current price of the stock by the latest quarter’s book value per share. P/B ratio is an indication of how much shareholders are paying for the net assets of a company. Generally, a lower P/B ratio could mean that the stock is undervalued, but again the definition of lower varies from sector to sector.
Price to Book Ratio = (Price per Share)/( Book Value per Share)
Dividend yield: – It is the portion of the company earnings decided by the company to distribute to the shareholders. A stock’s dividend yield is calculated as the company’s annual cash dividend per share divided by the current price of the stock and is expressed in annual percentage. It can be distributed quarterly or annually basis and they can issue in the form of cash or stocks.
Dividend Yield = (Dividend per Share) / (Price per Share)*100
For Example, If the share price of a company is Rs 100 and it is giving a dividend of Rs 10, then the dividend yield will be 10%. It totally depends on the investor whether he wants to invest in a high or a low dividend yielding company.
Market lot: – It is the minimum no of shares required to purchase or sell to carry a transaction.
Face value: – It is the price of the stock written in the company’s books when issued during IPO. It is the amount of money that the holder of a debt instrument receives back from the issuer on the debt instrument’s maturity date. Face value is also referred to as par value or principal.
Dividend % – This is the ratio of the dividend given by the company to the face value of the share.
Basic EPS: – This is nothing but Earnings per share.
Diluted EPS: – If all the convertible securities such as convertible preferred shares, convertible debentures, stock options, bonds etc. are converted into outstanding shares then the Earnings per share is called Diluted earnings per share. The less the difference between Basic and diluted EPS the more the company is preferable.
Cash EPS: – This is the ratio of cash generated by the company per diluted outstanding share. If Cash EPS is more the more the company is preferred.
Cash EPS = Cash flows / no of diluted outstanding shares
PBDIT: Profit before depreciation, interest, and taxes.
PBIT: – Profit before interest and taxes
PBT: – Profit before taxes
PBDIT margin: – It is the ratio of PBDIT to the revenue.
Net profit margin: – It is the ratio of Net profit to the revenue.
Assets: – Asset is an economic value that a company controls with an expectation that it will provide future benefit.
Liability: It is an obligation that the company has to pay in future due to its past actions like borrowing money in terms of loans for business expansion purpose.
Assets = Liabilities + Shareholders equity
Asset turnover ratio: – It is calculated by dividing revenue to the total assets
Debt to Equity Ratio: The debt-to-equity ratio measures the relationship between the amount of capital that has been borrowed (i.e. debt) and the amount of capital contributed by shareholders (i.e. equity). Generally, as a firm’s debt-to-equity ratio increases, it becomes riskier A lower debt-to-equity number means that a company is using less leverage and has a stronger equity position.
Debt to Equity Ratio =(Total Liabilities)/(Total Shareholder Equity)
Return on Equity (ROE): Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders has invested. In other words, ROE tells you how good a company is at rewarding its shareholders for their investment.
Return on Equity = (Net Income)/(Average Stockholder Equity)
Price to Sales Ratio (P/S): The stock’s price/sales ratio (P/S) ratio measures the price of a company’s stock against its annual sales. P/S ratio is another stock valuation indicator similar to the P/E ratio.
Price to Sales Ratio = (Price per Share)/(Annual Sales Per Share)
The P/S ratio is a great tool because sales figures are considered to be relatively reliable while other income statement items, like earnings, can be easily manipulated by using different accounting rules.
Current Ratio: Current ratio is a key financial ratio for evaluating a company’s liquidity. It measures the proportion of current assets available to cover current liabilities. It is a company’s ability to pay its short-term liabilities with its short-term assets. If the ratio is over 1.0, the firm has more short-term assets than short-term debts. But if the current ratio is less than 1.0, the opposite is true and the company could be vulnerable
Current Ratio = (Current Assets)/(Current Liabilities)
Quick ratio: The name itself tells quick means how well the company can meet its short-term financial liabilities. The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
Quick Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities.