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The Investor's Dictionary
Money Talk Made Simple
Trevor B
May 10, 2024
Summary
Welcome back, fellow rookie investors!
I'm happy you're here today because we're diving into a the continuation of a previous episode related to investing. Be sure to read the previous blog if you haven’t already.
Some investing terms are hard to understand sometimes and the idea of today’s episode is to define some of the ones that you will hear about the most so be sure to remember what each one means because understanding them can play a big role towards your financial success!
Investment Basics
Stock Market
The stock market is like a big marketplace where people buy and sell small portions of companies, known as "stocks." As we have said in previous episodes, purchasing a stock means you're buying a fractional piece of ownership in a company. The price of these stocks fluctuates based on various factors, including the company’s performance, economic shifts, or general public sentiment towards the company. The stock market plays an important role as it allows companies to gather funds needed for growth and expansion. If you want to read more on the stock market and brokers, be sure to take a look at this episode.
Revenue
Revenue represents the total income a company generates from its business activities, such as selling products or providing services. It's a critical financial metric that showcases the company's capacity to earn income from its primary operations. Revenue is typically reported on a company's income statement and serves as an important indicator of its financial health and performance. Investors closely monitor a company's revenue growth over time, as it reveals whether the business is expanding, stagnating, or facing declining sales.
Profit
Profit refers to the financial gain a company earns after deducting all expenses from its total revenue. It is the amount of money left over after covering costs such as production, operating expenses, taxes, and interest payments. It is a crucial measure of a company's financial performance and is usually reported on its income statement.
There are different types of profit, each providing a diferent insight into the company's finances:
Gross Profit: Revenue minus the cost of goods sold (COGS). It indicates the profitability of a company's core activities.
Operating Profit: Also known as operating income or EBIT (Earnings Before Interest and Taxes), it is calculated by subtracting all operating expenses from gross profit.
Net Profit: Also known as the "bottom line," it is the final profit figure after deducting all expenses, including taxes and interest, from revenue.
Market Capitalization
Market capitalization, commonly abbreviated as "market cap," measures a company's total value as determined by the stock market. It is calculated by multiplying the current market price of a company's shares by the total number of outstanding shares. In simple terms, it represents the total dollar value of a company's outstanding equity. Investors use this metric to classify companies into different size categories:
Large-Cap: Companies with a market cap above $10 billion. They are typically established, stable, and less volatile.
Mid-Cap: Companies with a market cap between $2 billion and $10 billion. They often represent growing businesses with a mix of stability and growth potential.
Small-Cap: Companies with a market cap between $300 million and $2 billion. They are usually growth-oriented and can be more volatile.
Micro-Cap: Companies with a market cap below $300 million. They often have high growth potential but come with higher volatility.
Market capitalization is a crucial metric for investors as it provides insight into a company's size, relative standing among peers, and its influence in the broader market. It's often used in investment strategies, portfolio construction, and benchmark comparisons. Companies with higher market caps typically have more significant influence on stock indices and attract considerable attention from institutional investors.
Equity
Equity is your ownership stake in a company, like owning a small part of Apple or Google if you have their shares. It comes in two main types: common stock, which usually lets you vote on company matters and receive dividends if declared, and preferred stock, which offers priority in dividends but often lacks voting rights.
Investors care about equity because it represents their claim on a company's assets and earnings. You can profit through capital gains (selling shares at a higher price) or dividends (payments from profits). The value of your equity can change based on the company's financial performance, market trends, and investor sentiment.
Insider Trading
Insider trading is when someone buys or sells stocks in a company based on information that isn't available to the public yet. This information could be anything that might affect the company's stock price, like news about its earnings or plans for the future. The people who typically have this kind of inside information are employees, executives, or people closely connected to the company.
When they use this information to make trades, it's considered insider trading, and it's illegal because it gives them an unfair advantage over regular investors who don't have access to the same information. This can lead to serious consequences, including fines, jail time, and damage to the integrity of the financial markets.
CAGR
CAGR, or Compound Annual Growth Rate, is a way to measure how fast an investment or a business, grows over time. It shows the average annual growth rate of an investment or business if it were to grow at a steady rate each year. Imagine you plant a seed and it grows into a tree. The CAGR tells you how much the tree grew each year on average, taking into account all the ups and downs in its growth. It's like looking at the tree's growth rate over a long period and seeing how much it changed each year to give you a clear picture of its overall growth.
For example, if you invested $100 in a stock and it grew to $200 over five years, the CAGR would tell you how much the investment grew on average each year. It's a useful tool for comparing the growth rates of different investments or businesses over the same period, helping you understand their performance and make informed decisions about where to put your money.
Liabilities
Liabilities are basically the things a company owes to others. It could be money owed to banks, suppliers who provided goods or services on credit, or even wages owed to employees. Think of it like a promise or a debt that a company needs to pay back in the future. Liabilities can include things like loans, bills that haven't been paid yet, or any other financial obligations the company has. Understanding a company's liabilities helps investors and analysts assess its financial health and how well it manages its debts.
Thanks for reading the second part of this “mini-series” where we talk briefly about the different concepts that are used in the world of investing. Next week, we're jumping into The Story Behind the S&P 500.
I haven’t bought any position this week so there is no news on that front. Wishing you a great weekend ahead, keep smiling, keep learning, and I'll catch you next time!
Trevor
Disclaimer: This post is NOT financial advice. It is intended for educational purposes only. Investing involves risks, and there is a possibility of losing capital. Always conduct thorough research and consider consulting with a financial advisor before making any investment decisions. Your financial well-being is important, so please invest responsibly.
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