Equity (Stock) Terminologies and Math

• Equity/stock is ownership in a company

• Dividends are excess cash that a company pays shareholders based on the shares owned.

• Types of stock instruments based on ownership:

  • Common Stocks - ownership of a company that are eligible to receive dividends

  • Preferred Stocks - receive promised dividends that are not available to common stocks (has preference over common stocks)

  • Convertibles - allows the investor to convert a bond into equity

• Types of stock instruments based on market capitalization (Market Cap) = all outstanding share of stock * price of the stock

  • Large Cap - top 100 companies in terms of market cap (often considered the most stable and less risky)

  • Mid Cap - 101-250 ranking per market cap (typically higher growth rates than large cap)

  • Small Cap - all remaining companies (typically higher volatility in stock price)

• Types of stock instruments based on economic trends:

  • Cyclical stocks - these stocks move in sync with the economy:  stock price drops when the economy declines and vice versa.

  • Defensive stocks - these stocks prices don’t react strongly to economic swings - less volatile stock price movements.

• Types of stock instruments based on profit sharing:

  • Income stocks - these stocks offer consistent dividends - typically companies that have strong finances and steady dividends.

  • Growth stocks - these stocks don’t offer dividends but instead reinvest their profits into the new growth opportunities.  These stocks usually have more volatility in price and are riskier than income stocks.

• Blue-chip stocks - these chips are typically large cap (well established), defensive (lower price volatility), and income (stable profits/dividends) stocks.

• Earnings per share (EPS) = net income / total outstanding common stock shares

• P/E Ratio - price to earning ratio that indicates investor anticipation of future growth

  • P/E ratio = Price of stock / earnings per share (EPS)

  • Used to compare one company to another within the same industry as an indicator of growth prospect expectations.  Investors usually use this to spot undervalued or overvalued stocks.

• Bull vs Bear Market - Bull market is characterized by rising stock prices, strong economic conditions (low unemployment), and high investor confidence and optimism.  A period of generally 20% or more increase in the recent low.  Bear market is the exact opposite.

• Market vs Limit Order - Market order is a directive to buy/sell immediately at the prevailing market price.  Limited order is a directive to buy/sell a specific price (which may not be executed if the market price doesn’t hit the specified price)

Exchange - a marketplace where stocks, bonds and other financial securities are bought and sold.  There are a few major stock exchanges in the US:

• New York Stock Exchange (NYSE) - to be listed on NYSE, a company must have 400 shareholders and 1.1 million shares

• National Association of Securities Dealers Automated Quotation System (NASDAQ) - largest electronic screen-based market that offers lower listing fees than NYSE

• American Stock Exchange - focuses mostly on exchange-traded funds (ETFs)

• Chicago Mercantile Exchange (CME) Group  - exchange for commodities and derivatives 

  • Chicago Board of Trade - an exchange merged with the original CME in 2007 focused in agricultural commodities and interest rate products

  • Chicago Mercantile Exchange - exchange focused in equity products, foreign exchange, and other products 

Stock Indices - basket of stocks (usually the most significant ones) to represent the overall health of a market.

• S&P 500 - tracks the performance of 500 of the largest publicly traded companies in the US.

• Dow Jones Industrial Average - tracks the performance of 30 of the largest companies in the US.

• Nasdaq Composite - tracks the performance of all stocks listed on the Nasdaq stock exchange.

Initial public offering (IPO) - process of offering shares of a private company to the public on a stock exchange.

Mutual fund -  an investment fund that holds a diverse portfolio of securities.  

• Open-ended: allows investors to buy/sell shares directly from the fund

  • Shared are traded at the end of the day

  • Price of the shares are based on the net asset value (NAV) of the fund, calculated at the end of the day.

• Closed-ended: fixed number of shares issued through an IPO and traded on a stock exchange (similar to stocks)

Exchange-traded fund (ETF) - an investment fund that holds a basket of securities (stocks or bonds) that can be bought and sold on an exchange like an individual stock.  

• ETF share prices change throughout the day similar to stocks prices.

• An investor buys shares of ETF which owns the shares of the underlying basket of securities

• Top 3 ETF providers

  • BlackRock under iShare name

  • Vanguard under Vanguard name

  • State Street under SPDR name

Index fund - a mutual fund or ETF that replicates a basket of underlying investments (common index funds attempt to replicate the return of a particular index) .  

• Usually has lower fees than mutual funds

• Index funds were popularized by John Bogle, the founder of Vanguard 

Commodities - global markets that trade precious metals, energy, raw materials, and agricultural products.  Commodities typically do not meet the definition of a financial instrument as they do not have a claim or obligation.