Trading shares can sometimes feel like visiting another country, especially when you’re just getting started. It’s so replete with its own terms and customs, it can seem a language to itself. This goes beyond the use of “equity”, “share” and “stock” to all manner of useful rules-of-thumb and jargon.
Here are a range of words and phrases that everyone should understand when trading.
1) Price to earnings ratio
The price to earnings ratio, often shortened to P/E or P/E ratio, is often used as a quick guide to how “expensive” a company’s shares are, given its profitability. The calculation is made by dividing the share price by the earnings per share, often comparing the result to the sector or the market as a whole. If the earnings per share is taken from the previous four quarters, it is called a trailing P/E. Using projected earnings per share reveals the leading or projected P/E, which is an indication of how an equity is priced given projected profitability.
2) Book value
This can mean a few different things, given context. When it comes to trading, you often find it listed among the company’s financials, or in a breakdown of the valuation. For a company, the book value is the total market value of all the assets the company owns, minus the liabilities — essentially an indication of the “value” of the company should it be liquidated. Comparing the “book value per share” – the book value divided by the number of shares with the current share price, can give a good indication of the market’s opinion of a company and how it is faring.
3) Market capitalisation
The market capitalisation of a company is simply the market value of all of its outstanding shares. If a company has 100 shares each valued at $10, the market capitalisation is $1000. Market cap is important to keep in mind not least because its often how companies find their way into the major indexes like the ASX200, an index featuring Australia’s largest public companies by market cap. But market cap can also be a guide for the maturity of a company, where it is in its life cycle, as well as the trade-off between risk and growth.
4) Ex-dividend date
The ex-dividend date is generally noted whenever a company announces a dividend — it is the cut-off date to be eligible to receive a dividend payment. The record date is 5pm on the date a company closes its share register to determine which shareholders are entitled to receive the current dividend. It is the date when all changes to registration details must be finalised. Anyone on the registry as owning the shares before this date will receive a dividend. If you take ownership of a stock after this date then the “seller” will receive the payment instead of you. Ex-dividend dates vary depending on the rules of the sharemarket, for the ASX it is usually two days before the “record date” — the day the company “closes its books” on who owns shares.
5) Dividend yield
Many investors buy shares purely for the dividends, and for them the yield, the possible return they will make on their investment, is one of the most important numbers. Essentially, the dividend yield shows the percentage of dividend income for the price of a given security. You calculate this by dividing the dividend per share by the price of the share — if the share is $1 and the dividend is $0.05 per share, the dividend yield is 5%.
In Australia dividends are taxed under a system called “imputation”. This means shareholders may be able to offset some of the tax on the dividend income they receive. Essentially, the company has already paid the company tax on the profit related to the shares – meaning shareholders can take advantage of this by way of “franking credits” attached to the dividends it pays out. This franking credit can cover, entirely or partly, the tax payable on dividends by shareholders, increasing their worth above face value.
7) T+1, T+2, T+3
Whenever you see “T+X” it is referring to the settlement of trades in respective sharemarkets. The T stands for transaction date, and the +X signifies the amount of days after the transaction when settlement – the exchange of securities and payment – occurs. In Australia the ASX operates under a T+2 system (recently reduced from T+3), which means that if a transaction takes place on a Monday, settlement will take place on Wednesday, to ensure there is enough time to for funds to appear. To ensure buy trades are settled, funds are required in the settlement account before settlement day.
8) EBIT/operating profit/operating income
EBIT, operating profit and operating income are all different names for the same thing — the profit generation from a company’s operations before interest and taxation are paid. This is an important metric to look at it, as it shows the underlying earning potential of a company, regardless of how it is capitalised or the tax framework in which it operates.
9) Working capital
A company’s working capital is an indispensable metric of its financial health. Calculated by taking away short-term liabilities (debts due within a year) from short-term assets (an asset that can be converted into cash within a year), working capital is a measure of a company’s ability to pay its creditors in the near term.
10) Return on assets
Return on assets, also known as return on investment, is a good indicator for judging the management of a company. The metric measures how much earnings a company generates from the assets under control — debt and equity. It is calculated by dividing income by total assets. The higher the ROA, the more the management is able to extract from the resources it has available. The lower the ROA, the less management is able to return on the equity you and fellow investors have provided.
From video tutorials to how-to-do guides, Commsec’s array of training resources can help you trade with confidence. For more share trading basics watch “Tips for beginners” at www.commsec.com.au/investinyourself to find out more.
IMPORTANT INFORMATION AND DISCLAIMERS: The information contained in this article is of a general nature and is not intended to be nor should it be considered as professional advice. You should not act on the basis of anything contained in this article without first obtaining specific professional advice. Commonwealth Securities Limited ABN 60 067 254 399 AFSL 238814 (“CommSec”) is a wholly owned, but not guaranteed, subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 23945 and both entities are incorporated in Australia with limited liability. To the extent permitted by law, its related bodies corporate, employees and contractors accepts no liability or responsibility to any persons for any loss which may be incurred or suffered as a result of acting on or refraining from acting as a result of anything contained in this article. CommSec is not responsible for third party websites or articles. They do not necessarily reflect the opinions of CommSec, nor does CommSec confirm their accuracy.
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