Key Investment Terminology

The amount of investment terminology that exists is so vast we could probably go on for days! However, most of the terminology does not reference things the majority of investors will deal with on a day to day basis, so we’ll stick to the basics.

Investment Products

Stocks ‐ When you buy stock in a company, you're purchasing a % of ownership in that company. The ability to buy that company’s stock is possible because investors can buy or sell its shares each day on a stock exchange. The value of the shares you purchase can go up or down in price depending on how the underlying company’s business prospects go.

Bonds ‐ A bond is an instrument where you essentially loan money to a company (or government, such as in US Government bonds). In return for your loan the company pays an interest rate, often referred to as the coupon rate. In addition to the interest, the company pays back, in full, the principal (the amount loaned). The date by which the loan is due to be paid back (in full) is referred to as the maturity date.

Mutual Funds ‐ A mutual fund is an investment vehicle that holds many investments on behalf of many investors, in a pooled investment vehicle. A mutual fund may hold hundreds of stocks, bonds or other assets with the purpose of spreading out risk. Typically mutual funds employ an investment team to run the fund, which consists of a portfolio managers and a team of analysts that research investment ideas to place in (or out) of the mutual fund.

ETFs - Exchange traded funds or ETFs as they are more commonly known, are marketable securities which trade on a stock exchange, as a single instrument, just like a stock. ETFs typically track an index, a commodity, bonds, or a basket of assets, but are combined into one actual instrument. Like stocks, ETFs have price changes throughout the trading day as investors buy and sell their shares. ETFs tend to be very liquid, which means you can buy and sell them easily, and they typically offer much lower fees than their mutual fund competitors.

REITs ‐ A REIT, or Real Estate Investment Trust, is a company that owns or finances income‐producing real estate. REITs typically trade in the form or a stock, ETF or mutual fund. The goal of a REIT is to provide investors income streams, as well as long‐term capital appreciation of the REIT instrument.

Options ‐ An option is a financial derivative (typically of a stock or index) that represents a contract sold by one party (the option writer) to another party (the option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed‐ upon price (the strike price) during a certain period of time or on a specific date (exercise date). Options offer you ownership in the related security for a much cheaper price (the option premium) versus buying the related security in the marketplace. However, the time horizon you own this option for is limited. If the underlying security hasn’t appreciated (or depreciated) in price enough by the time of your expiration date then the premium you paid for the option will become worthless. Call options are a bet that the underlying (related) security will go up, whereas Put options are a bet that the related security will go down in price.

Investment Styles

Asset Allocation ‐ Asset Allocation typically refers to investing across a range of investments, typically cash, bonds and stocks to create a range of investments that having varying risk levels. These varying risk levels can be tweaked by changing the % of monies allocated to the various asset classes. For example an aggressive investor will have more stocks than bonds or cash, whereas a more conservative investor will have less exposure to stocks, and more to bonds and cash.

Passive Investing ‐ Passive investing is an investment strategy that looks to maximize returns over the long term by keeping the portfolio constant and limiting the buying and selling activity. This strategy looks to keep fees and trading activity (costs) low and bets that market will rise over time.

Active Investing ‐ Active investing is an investment strategy that involves the ongoing buying and selling of securities typically by a professional portfolio manager. Active investors monitor their individual holdings and based on research and evidence make changes to the holdings of the portfolio. These changes can be frequent or not depending on the managers research and comfort level with the market or underlying securities in the fund.

Index Fund Investing ‐ Index funds track the performance and holdings of a group of stocks in an underlying, index, such as the S&P 500 Index. The S&P 500 Index is exposure to the 500 largest US stocks. Buying an S&P 500 Index fund will mirror the return on the S&P 500 Index. Index funds are popular because they are passive, low cost investment vehicles when compared to mutual funds.

Basic Stock Metrics

Price‐to‐Earnings Ratio ‐ The price‐to‐earnings ratio or P/E ratio is one of the best‐known, and most widely used fundamental ratios in the investing world. The P/E ratio is a measure of how overvalued (or undervalued) a company’s stock is. It is calculated dividing a stock's per share price by its earnings per share to come up with a value that represents how much investors are willing pay for each dollar of a company's earnings.

Not only do P/E ratios allow you to value an individual stock but it allows you a standardized metrics to compare one stock to another. Typically, the higher the P/E ratio the more overvalued the company, conversely the lower the P/E ratio the more undervalued the company is thought to be.

Price‐to‐Book Ratio ‐ The price‐to‐book ratio or P/B ratio is a measure of what investors are willing to pay for each dollar of a company's assets. The P/B ratio divides a stock's share price by its net assets, less any intangibles such as goodwill. By removing the intangibles assets the P/B ratio indicates what investors are paying for real‐world tangible assets, not harder‐to‐value non tangible assets. Similar to the P/E ratio low value suggest an undervalued company, while higher values suggest an overvalued company.

Debt‐Equity Ratio ‐ The Debt to Equity ratio is a measure that examines how much debt a company is carrying in relation to its equity value Similar to the P/E ratio, the debt to equity ratio indicates what proportion of financing a company has received from debt (like loans or bonds) and equity (like the issuance of shares of stock). Typically higher, Debt to Equity ratios are viewed as a negative as it suggests the company is carrying a heavy debt load. Conversely companies with low Debt to Equity ratios are viewed more favorably as they don’t have heavy loan repayments. One catch, in certain industries that are capital intensive and require regular equipment project financing acceptable debt to equity ratios can he higher and not considered an issue. Examples of a few industries where it is acceptable to have a higher debt to equity ratios are the oil & gas refining industry, heavy equipment/construction, and telecommunications.

Free Cash Flow ‐ Free cash flow, often referred to by its acronym FCF, is a measure of a company's financial performance, calculated as operating cash flow minus capital expenditures. Specifically, FCF is examines the amount of cash a company generates after factoring in all capital expenditures required to run the business. This excess cash generated, or FCF, is used to expand the business by increasing production, developing new products, reducing debt or making acquisitions.

PEG Ratio ‐ The price/earnings to growth ratio or PEG ratio as it is more often referred, is a variation of the traditional P/E ratio in that is also accounts for earnings growth. Like the P/E, the higher the PEG ratio ratio the more overvalued the company, conversely the lower the PEG ratio the more undervalued the company is thought to be.

Beta ‐ Beta represents the how volatile a security (typically a stock) price is relative to the swings in the overall market. A beta of 1.00 means the underlying security moves up or down in virtual lockstep the market (typically measured compared as to the performance of the S&P 500 Index). Conversely, a beta of less than 1 implies that the comparable security, in theory at least, should be less volatile than the broad market. A beta of greater than 1 indicates that the comparable security's price will be more volatile than the market.

For example, if a stock's beta is 1.5, in theory its upward and downward price movements should be 20% more volatile than the market (the S&P 500 Index). Conversely, if the security’s beta is 0.70, it’s upward and downward price movements (relative to the market or S&P 500 Index) should theoretically be 30% less than the movement of the market.

Lower beta typically means a less volatile investment or portfolio, whereas high beta typically means an investment or portfolio that has more swings up and down. Remember this has to do with the volatility of the holding or holdings, it doesn’t necessarily mean one will perform better or worse.

Alpha ‐ Alpha is a measure of investment performance (or return) above the level of return the market provided. It gauges the performance of an investment, or portfolio, against a benchmark such as an index. The excess returns of an investment when compared to the return of a benchmark index is the called the fund's alpha.

For example, if an investor used the returns of the S&P 500 index as a general benchmark for equity returns and in a given year the S&P 500 returned 10%, but the investor’s equity investments (portfolio) returned 15%, it would have achieved an excess return or alpha of 5%. Conversely if the benchmark, again the S&P 500 Index returned 20% and the investor’s investment returned 15% there is no excess return or alpha achieved because the strategy underperformed the benchmark.

Sharpe Ratio ‐ The Sharpe Ratio, developed by Nobel laureate William F. Sharpe is a measure for calculating risk‐adjusted returns. It was developed by. The Sharpe ratio is the average return earned in excess of the risk‐free rate per unit of volatility or total risk. Stated simply, a Sharpe Ratio examines how much risk in the investor/investment taking on to achieve its returns.

The Sharpe ratio is the average return earned in excess of the risk‐free rate such as on a U.S. Treasury bills (for which the expected return is the risk‐free rate). So a t‐bill would have a Sharpe ratio of exactly zero.

Generally speaking the greater the value of the Sharpe ratio, the more attractive the risk‐adjusted return of the underlying investment. This is important because it allows an investor to determine if the risk taken on to achieve the return is worth it. For example, if two investments, Investment A and investment B both achieved a 15% return, but investment A has a Sharpe Ratio of 1.20 versus investment B’s Sharpe Ratio on 2.1, investment B is the better investment as it provided the same return but took on a lot less risk to achieve those returns.

Basic Bond Metrics

Maturity Date ‐ The maturity of a bond is the length of time until the bond comes due and the bond holder receives the payment in full on the par value of the bond.

Par Value ‐ The par value is also known as the face value of the bond, which is the amount that is returned to the investor when the bond matures. For example, if a bond is bought at issuance for $1,000, the investor bought the bond at its par value. At the maturity date, the investor will get back the $1,000. The par value of bonds is usually $1,000, although there are a few exceptions. 

Coupon or Interest Rate ‐ The coupon or interest rate is the rate of interest that the issuer of the bond promises to pay the bondholder. If the coupon rate is 10%, the issuer of the bonds promises to pay $500 in interest on each bond per year (5% x $1,000 par value per bond).

This material is intended presented for educational purposes only and should not be used or relied upon to make investment decisions. Any references to returns are not to be relied upon as past returns may not be an indication of future returns.

Investors should carefully consider their personal investment objectives, risks, charges and expenses. Investing can result in the loss of some, or all of your principal, please consult a financial professional before investing.

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