If you are a new investor, you are likely to encounter terms that you do not understand. It may seem overwhelming at first, but once you become familiar with them, you will realize there is no reason to be intimidated. This is an introduction to some of the more common investing terms you may encounter.
These terms will be helpful to understand, so you don’t end up missing something you should know, or veering away from your financial goals. And it never hurts to know the basics.
An asset is anything of value or a resource of value that can be converted into cash. Individuals, companies, and governments own assets. For a company, an asset might generate revenue, or a company might benefit in some way from owning or using the asset. Personal assets may include a house, car, investments, artwork, or home goods. For businesses, assets are listed on the balance sheet and netted against liabilities and equity.
2. Return on Invested Capital
Return on invested capital (ROIC) is a profitability ratio. It measures the return that an investment generates for those who have provided capital, i.e. bondholders and stockholders. ROIC tells us how good a company is at turning capital into profits.
ROIC is most useful when you’re using it to calculate the returns generated by the business operation itself, not the ephemeral results from one-time events. Gains/losses from foreign currency fluctuations and other one-time events contribute to the net income listed on the bottom line, but they’re not really recurring results from business operations. Try to think of what your business “does” and only consider income related to that core business.
3. Margin of Safety
Margin of Safety (MoS) is the principle of investing in which an investor only purchases securities when their market price is significantly below their intrinsic value.
Why the Margin of Safety so important?
Stock markets are volatile (with a large upside followed by a downslide within moments in a single day) the rate of stock can skyrocket at one time and can rapidly come down in a single day. Since time immemorial, it is only a high MoS that can protect you from making extreme losses in this kind of market volatility.
Also, in case if an investor misjudges the value of a company, a high MoS would always protect him from huge losses.
4. Payback Time
Payback Time is the amount of time it takes before you get the return on your invested capital. Payback is used measured in terms of years and months, though any period could be used depending on the life of the project (e.g. weeks, months).
Payback focuses on cash flows and looks at the cumulative cash flow of the investment up to the point at which the original investment has been recouped from the investment cash flows.
If a business makes a million dollars a year, you want to know how long it would take you to get your money back in eight years or less at whatever price you were to buy it for.
Once you earn all that money back, you have no risk. You’re just playing with house money.
5. Index Funds & Mutual Funds
An index fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the S&P 500.
Mutual funds are doing the same thing that index funds are doing, except they charge higher fees. Both diversify your portfolio across hundreds of stocks.
Index funds are just very specific to the index that it’s tracking.
6. Earnings Per Share
Earnings per share are the net earnings of the company divided by the number of shares in the company.
EPS, also known as profit per share, is used to calculate the value of a business.
Make sure the cash flow of the company is as good as its earnings per share.
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