STOCK MARKET OVERVIEW AND KEY TERMS
Stocks
The stock price is the price of one share. Because stocks are traded in a public market, the price of a
share can go up or down depending on supply and demand. When a company issues stock, the buyer
gets a “share” of ownership in the company. In exchange, the company gets money it needs to grow.
Investors “own” a share of the Company’s future Earnings (also referred to as Profit, the Bottom Line, or
Net Income). If the Company is profitable, its shareholders benefit. If a Company is not profitable, its
shareholders lose.
Not every company has stock available to purchase in the stock market. (e.g. you cannot purchase
stock in the corner bodega).
When a company is part of a stock exchange it is a PUBLIC COMPANY. That is, shares in the company
are bought, sold, and owned by members of the public (i.e., investors).
Companies that trade on stock exchanges are identified by their stock symbol (or ticker symbol). Think
of these as “nicknames” for the company. SBUX – Starbucks; GOOG – Google
Understanding Risk and Reward
A critical difference between saving and investing is RISK. Unlike the banking world, where the FDIC
insures your deposits, in the world of stocks and bonds, there are no guarantees. So it’s important to
make informed investment decisions and do your research.
When investing money, you could make money, or you could lose some or all of it. Depending on what
you invest in, the risk ranges from low to very high. In general, the greater the potential for an
investment to increase substantially in value, the greater the risk it might also drop substantially.
What Drives Stock Prices?
Supply and Demand for the Company’s stock among investors determine trading prices. Demand is
driven by many factors including:
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Economic Indicators
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Expected Earnings – Investors pay close attention to a Company’s earnings in part because
shareholders get paid from bottom-line earnings (Net Income).
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Market Expectations – Value is driven by what the market expects will happen and what the
market thinks the company is worth (and long-term earnings potential). Sometimes it is not as
much about earnings, but more about overall potential to create value in the future (particularly
for newer companies or industries).
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Attitudes and Emotions – In addition to the Company’s performance, fear, speculation, rumors,
and emotions can also drive the markets, especially in the short term.
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Diversification
Diversification means ensuring that you have a mix of different kinds of investments in your portfolio.
Diversification is a primary way to reduce risk and maximize profit in a portfolio. Diversification can lower
the risk of an investment portfolio because not all industries or stocks move together.
For example, within your stock portfolio, it is important to own multiple stocks that are very different from
one another. (e.g., investing in Pepsi and Coca-Cola stocks do not achieve optimum diversification.
Their businesses are too similar, and their stocks likely move in the same direction at the same time.)
Owning multiple investments does not, in itself, mean a portfolio is fully diversified.
For example, if you own 20 different technology stocks (even if they are from 20 different tech
companies), your portfolio is not necessarily diversified.
Other Key Terms
Sector
Stocks that are grouped into the same sector share many common
characteristics. For example, stocks in the Technology sector are
characterized by high growth and high volatility (risk). By contrast, the Utility
sector is characterized by low growth, and low volatility.
Ticker or Stock
Symbol
Publicly traded companies are assigned an abbreviated form of their name.
The reason why these abbreviated names are often referred to as “ticker
symbols” is because years ago, it was easier to abbreviate the company
name when communicating trades on the hectic trading floor.
Stock Portfolio
A stock portfolio is a collection of stocks owned by an individual or group.
Stocks or Shares
Stocks are also commonly referred to as “Shares”. A share is a unit of
ownership in a publicly-traded company, a claim on the company’s assets
and future earnings.
Stock Market &
Stock Exchange
The stock market is a broad term to describe where stocks are bought and
sold. A stock exchange is a regulated marketplace where individuals can
trade stocks. In the US, the most dominant stock exchange is the New York
Stock Exchange (NYSE) followed closely by the NASDAQ.
Portfolio Manager
Portfolio Managers “PM” work at a financial services firm and oversee a
portfolio of investments for an institution or an individual.
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P/E Ratio
The Price/Earnings ratio reflects the price of the stock relative to its earnings.
A high P/E ratio indicates an “expensive” stock, and a low P/E indicates a
“cheaper” stock. The average P/E ratio for the overall market over time has
been around 15.
Beta
Measure of a stock’s risk to the overall market. A beta of one (1) means the
stock is as risky as the market, a beta greater than one means it is riskier that
the market, and a beta less than one means it is less risky than the overall
market. Investors combine high-beta and low-beta stocks to build a
diversified portfolio.
Earnings Per Share
(EPS)
The amount of Earnings (Net Income) the company made over the past 12
months, divided by the number of shares the company has outstanding.
Volume/Average
Volume
Trading volume is the total number of shares of that stock that have been
traded throughout the day. Average volume is measured over the last 30
days.
Market Cap
“Market capitalization,” is another way of measuring how much a company
is worth. (Calculated by the current value of all its outstanding shares of
stock)
52 Week High/Low
The highest and lowest prices at which a stock has traded over the past 12
months.
Stock Index
A stock index is a group or “basket” of selected stocks that are considered to
represent a particular sector of the US stock market or the economy. Instead
of having to follow the rise and fall of every stock in that particular sector, you
can do it almost as effectively by watching the rise and fall of the stock index
that represents the sector.
Examples of these are the Dow Jones Industrial Average (the DOW) and
Standard & Poor’s (S&P) 500 Composite Index.
Cyclical Stocks
The prices of cyclical stocks tend to move in the same direction as the overall
economy. They increase in good times and decrease in recessionary times.
When times get tough, consumers tend to pull back on their spending with
these companies. When times are good, consumers spend more with these
firms. (i.e. cars, travel, clothing)
Defensive Stocks
The prices of defensive stocks tend not to change dramatically compared to
the business cycle. They are steady and reliable even in economic
downturns. They are typically companies who sell goods and services that
are basic necessities that people cannot go without. (i.e. utilities, food)
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