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Stock Investing Terms for Beginners

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So, you are a new investor and have finally decided to get your feet wet and buy some stock! You fire up Google Finance (Google Finance) to do some research and search for your favorite company, let’s say Coca-Cola. You find the corresponding stock symbol (KO) and get the price quote. Next thing you know, you are staring at a screen littered w/ different terms, abbreviations, and ranges. It can all seems so overwhelming for a beginner. It was, and still is for me. So, how do you sift through all this seemingly esoteric data to extract the meaningful nuggets? Where do you begin?

To start, let’s take a typical quote for Coca-Cola (KO):

The big, bold quote of $68.83 reflects the current trading price. If the webpage is loaded during live trading hours (NYSE: 9:30 AM – 4:30 PM EST), then the number will update and refresh periodically to the new market price.

The -0.17 (-0.25%) is also dynamic, and changes to reflect the percentage change (positive or negative) of the current price to yesterday’s price (if the market was closed yesterday, the previous session’s closing price).

Pretty straight-forward so far.

The range (68.52 – 69.00) is the minimum and maximum price fluctuations for the day. This is a good indicator of how much the stock has moved during the course of a day.

Similarly, the 52 week range is the minimum and maximum price over the last year. As the saying goes, “Buy low and sell high”. This 52 week range will give you an indicator of how far away the current stock’s price is from its peak and valley.

Open price (68.69) was the stock’s price when the market opened that particular morning.

Ok, now let’s move on to the more interesting terminology:

EPS (Earnings per share):
In simple terms, this means,

More formally, you will see it defined as,

In the USA, the FASB requires all companies report EPS in their quarterly earnings reports. EPS is generally expressed over a full year.

The average shares outstanding is a dynamic, changing variable. It changes as the company issues new shares, repurchases existing shares, or issues options to employees. Because of this, EPS is often reported as a weighted average to account for these variations.

To calculate the EPS for KO above, we can pull up the ‘Financials’ tab on the side-menu. We can elect to display the data over a full year (2011):

*Note: Net Income and Diluted Weighted Average Shares are expressed in millions (USD).

Different finance pages may report the Income Statement using slightly different terms. Here is the statement from Morningstar (Morningstar):

Whereas Google Finance refers to it as ‘Diluted Weighted Average Shares’, it shows up here as ‘Shares Outstanding’. The numbers / calculations match, so it appears that they are referring to the same thing in this case. Although this may not always be so.

EPS is a very important number and is often cited over a range (3 years, 5 years, etc.) to gauge the stock’s recent performance. A stock exhibiting a trend of solid EPS growth is usually a strong catalyst to buy. Strong EPS projection into the future (or earnings exceeding analyst projections) usually help drive a stock’s price up.

This was the long, drawn-out way of showing you how EPS is calculated. In most cases though, you can simply refer to the number listed on the stock quote.

P/E (Price-to-Earnings Ratio):
The next important term, is the P/E Ratio. This number is often used as a valuation metric to determine how ‘fair’ the current stock price is.

In the KO example, we can calculate P/E since we know the current price and the EPS:

The number we calculated, 18.65 is slightly off from Google’s 18.67 (above). Hmm, rounding error perhaps? Let’s refer to a different finance website (Yahoo Finance) and see if we can get the numbers to match (pain-staking work, I know, but let’s be sure to verify our methods 🙂 )

Trailing P/E (Trailing Price-to-Earnings Ratio):
Since the EPS used was for last year (2011), this P/E ratio can also be referred to as the Trailing P/E ratio,

Forward P/E (Forward Price-to-Earnings Ratio):
Often times, it is also meaningful to project P/E over the next 12 months (4 quarters). The Forward P/E ratio,

Here is Morningstar’s (Morningstar) quote of KO showing the Forward P/E (EPS estimated to be $4.49 for 2012):

Typically, a stock with a P/E ratio below 10 is deemed under-priced. A P/E ratio between 10 to 20 is adequately priced, and P/E ratio above 20 is no longer a bargain. Of course, this is a very simple rule-of-thumb to follow. The ‘true’ value of a stock is determined by many factors. Also, P/E tells us nothing about: stock price relative to rest of industry, revenue growth, EPS growth, momentum, etc.

 

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