Common Stock Terms

When your account executive solicits (calls you and recommends that you purchase a particular stock), he or she may, as part of their solicitation, use such terms as “earnings per share,” “price/earnings ratio,” “book value,” “shares outstanding,” “total return,” and “price volatility.” The purpose of this post is to familiarize you with these terms and provide you with a brief description of what each means. These descriptions are not designed to be all-inclusive. Rather, this information is being provided for educational purposes only. For further explanation thereof, you should contact an experienced professional. Also, please keep in mind that this information is being provided for informational purposes only and is not to be considered as legal or investment advise.

These terms have a great deal of significance in arbitration suitability claims made by customers. These items are taken into consideration in determining whether or not a particular transaction is suitable for the customer. Having an attorney who understands these concepts is important so your chance of success is enhanced.

Earnings per share (“EPS”) is the company’s net income divided by the number of common shares outstanding. Simply, it is the portion of the company’s profit (or net profit) for each share of stock. A company’s growth rate is often determined by how its earnings per share have changed over the years. Finding a company with a strong earnings growth is usually advisable for the average investor. Obviously, EPS is a historical picture of the company’s growth pattern and while past performance may not be indicative of future results.

As with EPS, a company’s price-to-earnings (P/E) ratio is also an integral part of the stock selection process. P/E ratio is computed by dividing the stock price by the earnings per share, which tells the investor how much he or she will be paying for one dollar of the company’s earnings. Because stock prices usually reflect investor demand, the P/E ratio tells you the price investors are currently willing to pay, or the stock, in proportion to the company’s earnings. For example, A P/E ratio of 20 means that investors are willing to pay twenty times more for a stock than the stock’s earnings per share.

When investigating a particular stock, compare its P/E ratio with that of other companies in the same industry class. Since every industry has its own unique qualities, you will want to find out what the average P/E ratio is for that sector. If a company has an exceptionally low P/E ratio compared to others in its industry class, find out why. For example, the company’s growth could be stagnant or it could be burdened with excessive debt. Alternately, it could simply be undervalued, making it a great buy for value investors.

A company’s book value per share is calculated by subtracting its liabilities from its assets, then dividing the result by the number of shares outstanding. Generally, book value shows the investor the company’s net worth. This is a tool that can be used by an investor to figure out what the company’s net worth is, which then can be compared to the book value of other companies in the same industry.

Shares outstanding refer to the number of shares a company has issued to the general public, including its employees. Authorized shares refer to the total number of share authorized by the company’s articles of incorporation.

Price volatility refers to how much the share price of a stock varies, which is usually calculated by looking at the difference between a stock’s high and low prices over a set period of time, which is deemed relevant by each investor. Price volatility is one factor in determining the risk of an investment. When dealing in stocks, the term that describes price volatility is beta. Beta is a quantitative measure of the variability of the stock when compared to the market as a whole.

On method of determining beta is to compare the changes in a stock’s price against the S&P 500 stock index. For example, a stock with a beta of 2 moves twice as much as the S&P 500. From a statistical standpoint, this would mean that a stock would a beta of 2 can be expected to rise in price by 40 percent if the S&P 500 rises by 20 percent or drop by 40% if the S&P 500 falls by 20 percent.

Many investors that purchase and sell stocks tend to think about their gains and losses in terms of price changes. Has the price of the stock increased or decreased from the price at which it was bought. On the other hand, those investors that purchase and sell bonds tend to pay attention to interest yields and usually don’t focus on price changes. However, unless the investor is fixated on these measures, both approaches are incomplete.

Although yields may be more important if you are seeking income and price changes are more important if you are looking for growth, total return on any stock investment is important. If you know a stock’s total return, it makes it possible to compare your stock investments with other types of investments, such as corporate bonds, municipal bonds, treasuries, and mutual funds.

To calculate total returns, add the stock’s price change (or subtract it if the price has gone down) and dividends for the past twelve months and then divide by the price at the beginning of the twelve month period.

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