Here's an alphabetical list (Glossary) of all the technical terms you may ever come across.
Some you may have heard of before, some you may not, others you may have been too embarrassed to ask what they were.
Now you don't have to be embarrassed. This Glossary covers most, if not all, the technical terms you are ever likely to come across.
Alliance Trust Savings:
Alpha is used as a way to measure a fund manager’s performance. It is the amount of value a fund manager adds or takes away from an investment portfolio.
Alpha can be looked at in two ways:
Firstly, by comparing the fund’s performance against a benchmark index. If the manager’s portfolio returns 10% compared to only 5% for the benchmark index, then the manager is said to have generated a positive Alpha of 5%.
Secondly, the risk profile of a portfolio can be compared to a Capital Asset Pricing Model (CAPM) which would predict what the fund should achieve.
If CAPM predicts a portfolio return of 12% but the actual return is 15%, then a positive Alpha of 3% has been achieved.
American Depository Receipt (ADR):
ADR stands for American Depository Receipt.
ADRs trade on the US Stock Exchange and are used to help American investors buy stock in foreign companies.
ADRs are issued by US Banks.
The ADR represents a stock, or stocks, of a foreign company.
Tangible assets (such as machinery) decrease in value over time and this is known as depreciation. Amortisation is the same thing except it applies to intangible assets.
Amortisation is mostly used when one company buys another.
Most companies are valued at a premium to their assets. Normal accounting methods would see this as a loss, even though the company comes with hidden assets – Branding, market position etc.
The difference between the value of a company’s assets and the price paid is recorded as “goodwill” and is written off (amortised) over time, just as tangible assets are written off via depreciation.
Companies can manipulate profit figures by adjusting subjective calculations such as depreciation and amortisation.
Analysts invented an alternative profitability measure EBITDA which stands for Earnings Before Interest, Taxes, Depreciation and Amortisation.
This accountancy practice makes it easier to compare two companies without distortion.
Annuity: An annuity promises to pay the buyer a regular income in exchange for a lumpsum payment.
This is usually a lifetime income but may also be for a fixed period.
Until quite recently, most people retiring had to convert their pension pots into annuities by the age of 75 at the latest.
But, because life expectancy was longer and falling interest rates have driven down the amount paid by annuity companies, annuities have become increasingly unpopular.
However, it is now no longer necessary to take out an annuity on retirement. Pensions can be kept invested and drawn as, and when, required.
Some people still purchase annuities either as a whole part of their pension or a as part of their pension, thus providing them with some reliable and guaranteed income in retirement.
Annuities come in different shapes and sizes.
The simplest type of annuity pays out a fixed annual amount. But the real value of this pay-out gradually declines over time because of inflation.
Therefore, the majority of annuity purchasers go for index-linked annuities where the payments rise in line with the consumer price index (CPI).
It is also possible to buy an annuity that continues to pay out to your spouse should you die before them.
Other annuities may pay out larger sums to people with lower life expectancy, such as smokers, or those with heart problems.
But, as you would expect, the more “conditions” you have to your annuity, the lesser the pay-out will be.
Asset Allocation: see also ‘Diversification’
Asset Allocation is the process of how you decide how to split your investment portfolio between your different assets, such as stocks or bonds, or even alternative investments such as collectibles.
One common form of Asset Allocation is to split your portfolio 60/40. Which means that you place 60% of your investment portfolio into stocks and 40% into bonds.
The main point of Asset Allocation is to be a tad conservative. Not putting your entire portfolio at risk. For example, placing your portfolio 100% into stocks and 0% into bonds wold be regarded by many, as risky.
Usually, investors are less risk averse depending on their age and how near to retirement. Stocks are recognised as being more risky than bonds but historically have performed better.
Therefore younger people may have a higher proportion of their portfolio in stocks than bonds, say, 80/20, whereas nearer retirement they may opt for a 60/40 or even a 40/60 split.
If you are particularly good at stock picking, you may want to remain an 80/20 or maybe even a 100/0 investor!
Baby Boomer is an expression used to describe anyone born in the years after World War II. Typically those born between the years 1946 and 1964.
Baby Boomers have had an impact on western economies and as such have had the attention of a lot of target marketing.
They are deemed to be among the most affluent generation. They have money to spend and are also already in, or approaching retirement age.
Balance of Payments: See also Current Accounts and Capital Account.
The Balance of Payments is a record of all transactions that a country does with the rest of the world.
It consists of two parts: the cu rrent account and the capital account.
The sum of the current account and the capital account must balance.
However, a country can have a balance of payments surplus (its central bank is accumulating reserves) or a balance of payments deficit (its central bank is running down its reserves).
A balance of payments crisis occurs if a country can no longer pay for import or service its debts which is usually caused by a sudden stop in inflows (or large outflows) in the capital account.
Baltic Dry Index:
The Baltic Dry Index (BDI) is issued by the Baltic Exchange daily and is a composite of the Capesize Index, the Panama Index, and the Supramax Index, it is an assessment of the freight costs of some 20 major routes.
It is regrded the world over as the bellwether for general market bulk shipping stocks.
It succeeded the Baltic Freight Index (BFI) in 1999 and it weighting changed in 2018 to comprise of 40% Capesize, 30% Panama, and 30% Supramax. It previously had another constituent, the Handysize Index, but this was dropped having only represented 10% of the BDI.
The purpose of the BDI is to measure the demand for shipping capacity against the supply of dry bulk carriers. The demand for shipping varies with the quantity of cargo that is being traded, i.e. the supply versus the demand.
Baltic Capesize Index:
This index is the largest of the three indices that make up the Baltic Dry Index.
It comprises of the 5 largest shipping routes (assessed by tonnage). The Capesize index represents ships with a tonnage up to 180,000 dwt.
Baltic Panamax Index:
This is the second index that makes up the Baltic Dry Index and comprises of 5 shipping routes that cater for ships with a tonnage of up to 82,500 dwt.
Baltic Supramax Index:
This is the third index that is a constituent of the Baltic Dry Index.
It comprises of 10 shipping routes with a tonnage up to 58,328 dwt.
Baltic Dirty Tanker Index:
Baltic Handymax Index:
Up util January 2018 the Handymax Index was a constituent of the Baltic Dry Index representing 10% of the BDI. It is now just a stand-alone index.
Barron's 400 Index:
B/C Share Scheme:
When companies have more money than they need, they may decide to give some of it back to shareholders.
This is commonly done by issuing new types of shares, called B shares, or C shares.
Soon after issue, the company repurchases and cancels the B shares, thus giving the B owners a profit which is taxed as a capital gain.
C share owners get paid an equivalent dividend, taxed as income. The C shares are then cancelled.
The schemes allowed shareholders to choose between receiving their payments as income or capital.
In 2015 both these schemes were discontinued.
A.J. Bell YouInvest:
Beta is used by professionals as a way of measuring the risk of an individual stock compared with the risk of the stockmarket as a whole.
Beta is a measure of volatility.
A stock with a Beta of 1 moves in line with the stockmarket as a whole.
A Beta of more than 1 indicates that the stock is more volatile than the market.
A Beta of less than 1 indicates that a stock is less volatile than the market or a stock that doesn’t move in the same direction as the market.
Utilities, for example, usually have lower Beta values than say technology companies or smaller (i.e. riskier) companies.
During time of uncertainty, investors will switch to low Beta stocks.
Conversely, in bull markets, they may want to switch into high Beta stocks to take advantage of the rising markets.
Bid/Ask: Also known as Bid-Ask Spread.
When a price of a stock is quoted in the newspaper, it’s usually just one price that you see. This is known as the middle price.
However, when you are ready to trade you will be quoted two prices. The Bid and the Offer price (or Bid and Ask price).
The Bid price is the price that the market is willing to pay for your stock.
The Offer price is the price that the broker is willing to sell them to you for.
The Bid-Offer Spread, as it is known as, is a hidden cost that you have to pay when buying stock. It is how the people who make a market for stocks (market makers) make their living.
It is a separate cost and in addition to stamp duty and broker’s fees.
The spread is greater for stocks that are rarely traded in the market.
The spread is small for very liquid traded companies – such as blue chips.
Bid-Offer Spreads are also a feature of Investment Trusts and Exchange Traded Funds (ETFs) and as such, represent an additional cost when investing in them.
In volatile markets, the Bid-Offer Spread for illiquid companies can become quite large (several percentage points – 10-15% is not uncommon).
Yet another reason for only trading in liquid stocks.
Bid/Offer Spread: Also known as Bid/Ask Spread
Binaries, or more commonly Binary Options, are type of financial option that makes a fixed payout if a certain event occurs but expires worthless if that event doesn’t occur.
Binaries are quoted anywhere between 0 and 100. Which is a view on the probability of an event happening. 100 means that the event is certain to happen and 0 meaning that the probability of the event happening is impossible.
When trading Binaries you would buy if you think the event is going to happen and sell if you think the event is unlikely to happen.
Price anywhere between 0 and 100 are quoted . For example, if the DJIA was quoted at 50 for the index to rise by the end of that day’s trading you could buy at 50 for say £1 per point (i.e. £50). If the index closed higher you would make £50 and if it closed lower you would lose £50.
A day’s trading is around 8-9 hours and the binary price quoted for an event can vary a lot during that period. So if you bought a binary at 50 very early on in the trading day, the price quoted could fluctuate wildly, you do not have to wait until close of play, you could trade your position at any time of the time making either a loss or a profit.
A Bond Ladder is a strategy used by bond investors that look to secure a steady source of income and spread their risk.
Investing in a Bond Ladder involved investing equal amounts of money in bods with evenly spread maturities (the maturity of a bond is the date at which the bond is repaid to the holder at its face value).
A five year ladder would have equal amounts invested in bonds with one, two, three, four and five year maturities.
The investor knows what he is going to receive each year from his payments. As one year a bond matures all the other bonds move down the “ladder.”
So to keep the ladder going, another five year bond is bought.
A Bond is an I.O.U. issued by a government or corporation. It promises to pay a set amount of interest (the coupon) each year, to then return the investor’s money at the end of that set period.
This date is called the Bond’s maturity.
Investors like longer maturity bonds as they promise to pay higher interests.
Bond Proxy is a phrase used a lot in these days of low interest rates.
It describes a stock that is seen as fulfilling the functions of a bond.
Traditionally, bond investors want a secure, reliable income and a high level of confidence that they will get their money back.
With interest rates low, bond investors feel obliged to seek better interest elsewhere. Hence the switch to “Bond Proxies,” i.e. shares in blue chip companies that make steady profits, pay regular dividends, and are judged to be safe investments.
The “Consumer Staples” sector are seen as recession proof because no matter what the state of the economy, they will always sell goods that consumers need.
Bond Yield: A Bond is an I.O.U. issued by a government or a company.
Bond Yields measure the return on this I.O.U.
Usually, the Bond pays a fixed amount of interest every year until a date in the future known as the redemption date or maturity date.
On maturity, the government or company, repays the “face value” of the Bond, usually £100.
The ‘flat’ yield measures the annual income return. The Gross Redemption Yield (GRY) measures the total return (pre-tax) taking into account the annual income paid out and any capital gain (or loss) up to the redemption date.
Better explained with an example: a five year Bond with witha5% coupon is trading at £95. The flat yield is the annual £5 payout as a percentage of the price – i.e. £5/£95 x 100% = 5.26%
Getting to the GRY is more difficult: £5 annual income, plus £1 annual capital gain (bought for £95 but repays at £100), hence the GRY is £6/£95 x 100% = 6.32%
But if inflation were to be taken into account, the calculation would be a lot more complicated.
Book Value is also known as Equity, Shareholders’ Funds or Net Asset Value (NAV).
The number can easily be found in a company’s balance sheet in the annual report.
Book Value is used as an estimate of what a company would be worth if all of its assets were sold for their balance sheet values.
A big problem of valuing a company this way is that book value may contain a lot of intangible assets, such as goodwill.
Intangibles may not be worth much at all.
By taking away these guesstimates from the book value leaves what is known as the tangible book value, which is based on actual assets – land, building, cash etc.
Divide this figure by the number of shares in issue and you will get the tangible book value per share and if an investor can buy stock for less than this number – you may have found a bargain.
Bovespa Index: The Bovespa index is the benchmark index of Brazil. Financials account for almost 40% of the index.
The income a government receives for spending on public services varies with time. The main source of revenue is tax.
Tax revenues fall during a recession and rise during a boom period.
Therefore, if a government wants to maintain its level of public spending during a recession, then it needs to run a Budget Deficit (i.e. its annual spending is greater than its annual income).
This is usually finance by borrowing money from the bond markets. This adds more to the national debt.
A Budget Deficit caused by a temporary overspend is known as a “cyclical deficit” because it will be financed by surpluses when the boom period arrives.
However, some governments persistently run a Budget Deficit. This is known as a “structural deficit” and is an indicator of a government’s financial management.
Bulls and Bears:
A Bull is an investor who thinks the market will rise. A Bear is an investor who thinks the market will fall.
A falling market is known as a Bear Market. The difference between a bear market and a temporary correction is that for it to be classified as a bear market it has to have fallen by at least 20% for at least two months.
A Bear Market is reckoned to be over when prices have bottomed out reaching lowest point.
A Bull Market is the exact opposite of a Bear Market, i.e. prices must have risen by 20% for at least two months.
Historically, stocks have risen more over the log term, meaning that Bull Markets are longer than Bear Markets.
Gins made in Bull Markets tend to be more than the losses made in Bear .Markets.
Take the period 1926 to 2014, the average American Bear Market lasted an average of 1.3 years and had cumulative losses of 41%. But the average Bull Market lasted 8.5 years and had an average gain of 45%.
There are more ways to return cash to shareholders than by paying a dividend. A company may choose to buy back its own stock.
Why would it do that?
Because a company’s post-tax profits will be spread across a lower number of shares, and the earnings per share (EPS) would rise because of it.
Companies that do this hope that the higher EPS will lead to a higher stock price.
A secondary reason for companies doing this is that dividends are taxed at a higher rate for higher rate taxpayers. Thus, Buybacks are seen as a better way of rewarding them.
But, a higher EPS does not necessarily mean that a company is worth more (especially if the company has borrowed to finance the Buyback).
Buy-Side: See also Sell Side.
Buy Side analysts are typically employed by fund managers.
The aim of these analysts is not to obtain business but the help the investment manager make better and more profitable decisions.
Sell Side analysis is generally made available whereas Buy Side analysis tends to be unavailable to the publicly.
Call Option: see also – Put Option
A Call Option gives the holder the right, but not the obligation, to buy something (usually a share) at an agreed price on or before an agreed date.
To have this right means that you buy a Call Option.
This is done by paying the seller of the option (known as a ‘Writer’) a premium. Call Options are bought is the buyer think a share price is going to go up.
For example, suppose a share trades at 80p. A Writer quotes 10p premium to buy a Call Option for the right to buy the shares in 3 months’ time at 100p.
For the option buyer to make a profit the price of the share would need to rise to 100 + 10 = 110p (the target price plus the premium).
If the price of the share does increase then the value of the Option will also increase (because the target price of 100p is now more attractive).
The strategy of buying a Call Option is attractive because it allows the purchaser to take a stake in a quantity of shares for a much smaller amount than if he’d bought the shares outright (10p premium versus 80p share price).
The downside being that if the shares do not go up in value then the purchaser could lose money. If the share price in the above example didn’t go up then he would lose his total investment.
Most investors tend to use the Price/Earnings Ratio (PER) to value a share. The PER is arrived at by dividing a company’s share price by the company’s earnings per share.
A low PER suggests that a company may be cheap whereas a high PER suggests that the company’s stock may be expensive.
By simply using the PER, the analysis could be misleading.
By using just one year’s profits, particularly if one from a cyclical business, may appear cheap because profits may be peaking for that year and may turn down the following year.
In the 1930s, value investors Benjamin Graham and David Dodd proposed that earnings for the past 5-10 years be taken into account. This, they reckoned, would average out any cyclical effects.
Graham’s and Dodd’s findings were later revived by two Yale University members who statistically proved that 10 years of a company’s average earnings strongly linked to the company’s next 20 years of earnings.
This 10 year cyclically adjusted PER became known as the ‘Cape’ ratio.
Capital expenditure, shortened to Capex, is the purchase by a company of fixed assets such as land, buildings, equipment etc.
It is usually one of the largest uses of a company’s cash flow.
Capex is normally split into two parts, Maintenance Capex and Expansionary Capex.
Maintenance Capex is the money that a company spends on replacing worn out assets whereas Expansionary Capex refers to investment in new capacity designed to grow the sales and profit of the business.
Large businesses such as energy companies, mining, telecoms, utilities, will have a high Capex spend, whereas industries such as financials, media, healthcare, may spend very little.
For investors, it’s not just how much or how little a company spends on Capex, it’s if the company gets a return on that spend.
Weak returns are of no interest to shareholders. Capex projects usually have to deliver a payback (in terms of years) for the projects to even get the go ahead.
Capital Account: See also Current Account.
The Capital Account is one of two key measurements of the flow of money between a country and the rest of the world.
The other key measurement being the Current Account (see above).
The Capital Account represents the net change in private and public ownership of physical and financial assets.
If a country is running a capital account surplus, it means that foreign investors are bringing more money into the country than local investors are sending abroad.
This means that foreigners are increasing their net ownership of national assets.
However, if a country has a capital account deficit, it means that investors are sending more money overseas than is coming in, and the nation is increasing its net ownership of foreign assets.
Capital accounts and current account must always balance. Therefore, if a country has a capital account surplus, it will also have a current account deficit.
Capital Asset Pricing Model: (CAPM):
The Capital Asset Pricing Model (CAPM) is sometimes used by professional investors to work out the expected return on a share or a portfolio of shares.
Firstly, you would need to know is the “risk free rate”. This is usually the redemption yield on 10 year government bonds, that is, the return you would get if you bought and held a 10 year government bond until maturity.
Then you would need to add a “risk premium.” This is any additional return you might expect to get from the market as a whole.
To get this you might use the formula:
Rf (the risk free rate) + (beta multiplied by the risk premium).
Beta compares the ‘riskiness’ of an individual share with the stock market as a whole.
A beta above 1 means that the share is more risky than the broader market while a beta less than 1 means it is less risky.
If government bonds yield 3%, the beta of the stock you are looking at is 1.2 and the risk premium is 4% then the return you’d be aiming to get is 7.8%.
Capital Controls are measures that a government uses to regulate the flow of money in and out of a country.
Usually this means limiting the amount of money that businesses and individuals can take out of the country.
Capital Controls are often imposed during times of crisis in an attempt to prevent capital leaving a country and maybe destabilising the financial system.
Capital Controls were e key part of the Bretton Woods system of fixed exchange rates from 1940 to 1970 but were discontinued by developed countries as the world moved to a system of floating exchange rates.
An asset’s “carry” is the amount of interest it produces.
For example, in a currency trade the carry is what you can make by depositing the currency at the Central Bank.
In the foreign currency exchange market a Carry Trade involves borrowing in a currency with a low interest rate and using the money to buy a currency that pays a higher interest rate.
If the exchange rates remain constant you will be paid more interest than what you pay.
Take for example the U.S. where interest rates are higher than in the U.K. (0.5% compared to 0.25%) so buying dollars and selling Pounds would technically be a Carry Trade.
It sounds like money for nothing. But Carry Trades are extremely risky. If a trade reverses and everyone tries to get out at once, gains can turn into losses VERY quickly.
Good companies need to make a profit. Their income must be more than their costs.
But with creative accounting profits can be manipulated and thus not reflect the reality of a situation.
Clever investors will look at a company’s ability to generate hard cash.
Companies that can’t generate hard cash can be a poor investment and may even go bust.
Making profits is one side of the coin but the other side is how well does a company convert these profits into cash.
Number crunchers do this by comparing the operating profit from a company’s income statement with the operating cash flow number from its cash flow statement. [See also Income Statement and Cash Flow Statement].
For example, if a company has an operating profit of £100m and operating cash flow of £70m it has what is called a cash conversion ratio of 70%.
You could also compare a company’s net profit (the money paid out in dividends) with its free cash flow (the money left over after all costs have been paid).
Cash Flow Statement:
Passive investment funds or “trackers” invests in a basket of stocks to mirror the performance of an underlying stock market or index, such as the S&P 500 index or the FTSE 100 index.
Index Funds don’t employ analysts to invest in individual stocks. They invest in them all.
An Index Fund won’t beat the market but it will track the market and slightly underperform it (after costs.)
Active Funds are different. They charge higher fees and employ professional stock pickers in the hope of beating the market.
But, in some cases an active manager will pick a portfolio that is little different from the overall market. Theses Funds are called “Closet Trackers.”
They charge higher management fees yet only deliver a passive return.
Closet Trackers should be avoided as they charge ‘active’ fees but only give a ‘passive’ performance.
Clearing Houses are a vital part of the financial system. You don’t generally hear about them unless something goes wrong.
When you buy shares through a stockbroker, they will do the deal through the Stock Exchange. Your stockbroker agrees to buy an agreed number of shares at an agreed price. The deal usually settling in 3 days.
But there is a risk. Either the buyer doesn’t pay or that the seller doesn’t deliver the shares.
This is where the Clearing House steps in. It takes over the deal and guarantees the trade.
The seller agrees to give the shares to the Clearing House and the buyer agrees to pay the money due. For the deal to work, the buyer and seller have to pay a deposit to the Clearing House. This is normally a percentage of the trade and is known as a “margin.”
When the deal is done the deposit is returned.
In hard financial times, margins are increased if the Clearing House thinks that the buyer or seller won’t honour their contract.
Compound Interest is the process of earning interest on interest that you’ve already been paid.
Here’s an example: you have £1000 and you earn 5% interest per year. After one year you would have £1050. After two years you would have £1050 x 1.05 = £1102.50
Simple interest is where you only earn interest on the original amount invested. In the example above, with simple interest you would have £1050 after year one, but only £1100 after two years.
A small difference but the magic of compound interest mounts up over time. That’s why Einstein dubbed it “The Eighth Wonder of the World.”
Now, here’s a neat (but simple) little trick you can use with a dividend paying stock:
Instead of receiving your dividends and frittering them away – use them to buy more stock in the company. If you have a “forever” share in your portfolio (as described on this website) you should use the dividend to buy MORE stock in the company. This, in turn, pays you more dividends. Repeat the process over say a decade, or more, and you’ll be surprised how much of a nest egg you now have.
Most listed companies do not have a fixed lifespan. They continue to trade until they go bust or are taken over.
Which means that successful companies have been around for a long time.
However, listed investment companies, aka investment trusts or closed-end funds, may be different.
The business of these companies is to invest in stocks and other securities rather than running an actual business.
If these companies underperform the market persistently or if their investments mature, it may be best for their shareholders if they are wound up.
In order for this to happen it may be best if, according to the company’s Articles of Association, the company’s shareholder get to vote on whether the company should continue to exist.
This is known as a Continuation Vote.
It is usually triggered annually or after a certain period of time, for example, five years after the fund was set up.
If shareholders were to vote against continuation, the assets of the fund would be sold and cash would be returned to the shareholders, with the company being wound up.
Convertible Bonds pay a fixed amount of interest each year and promise to return your original investment at the end of the bond’s life. The same as conventional bonds do.
The difference being that Convertible Bonds offer investors the opportunity to convert their bonds into stock, if the stock price goes above a pre-set level before a certain date.
This is known as the ‘conversion price’.
If the stock falls in value then holders simply collect their bond interest and get their initial investment back when the bond matures.
Here’s an example: suppose a company issues a five year convertible bond due to be repaid in 5 years’ time. It pays an annual rate of interest on its par value of 1.5% with a conversion price of 800p
This price being 30% higher than the company’s stock price at the time of issue.
Correlation is a statistical measure of how closely two things move together over time.
In investment terms it can relate to the relationship between different asset classes or securities.
For example: if tow stocks are positively correlated their prices will tend to move in the same direction. If they have a negative correlation, they tend to move in opposite directions.
Correlation are expressed as “correlation co-efficient” which is a number between +1 ad -1. +1 means a perfect positive correlation, 0 means that there is no consistent relationship and -1 means a perfect negative correlation.
Professional investors use correlation to help them manage risk. By selecting investments that do not have strong positive correlations, they aim to reduce the overall level of volatility in their portfolios.
Corporate loans usually have a set of rules that the borrower has to adhere to.
These rules are known as covenants and are there to protect the lender.
Covenants that are well-written are designed to protect the lender who then has a good chance of receiving his regular interest payments and getting back his original lump sum.
Sometimes, a loan will have a covenant that has states that interest rates must be covered x number of times by a borrower’s trading profits. This is known as ‘interest cover’.
Another covenant might insist that the debt is a certain percentage of the borrower’s assets.
Covenant-Lite (sometimes shortened to Cov-Lite) loans don’t have these rules. Such loans are given to highly indebted companies that are usually owned by private-equity investors.
These loans are risky for the lenders.
Because of the risk, lenders impose a higher rate of interest that they would otherwise do for a less-risky client.
Credit Default Swap (CDS):
Credit Default Swaps (CDS) are a form of insurance contract written on fixed-income securities such as bonds.
They are issued by sellers (e.g. banks) to buyers who want to protect themselves against the risk of the bond issuer going bankrupt.
The buyer of a CDS agrees to pay the seller a premium for an agreed amount of time. In return, the seller agrees to pay any lost interest and also the money initially invested if the bond issuer goes bust.
What the buyer of the CDS is really doing is transferring the bankruptcy risk of the bonds to the seller of the CDS.
Credit Rating is the assessment of the ability of a borrower (an individual, a company, or a government) to pay interest on a load and eventually repay the loan.
Companies and governments borrow money by issuing bonds to investors. They pay Credit-Rating Agencies (see below) such as Standard and Poor’s, Moody’s, or Fitch, to give their bonds a rating.
Strong economies and companies that have enough income to pay interest and the loan capital have higher ratings. High ratings being AAA from S&P and Fitch, or Aaa from Moody’s.
A change in credit rating can lead to a change in the rate of interest that a company pays.
Credit Rating Agency:
When a company or government wants to borrow money by issuing bonds, those bonds will usually be assigned a credit rating.
This serves as a guide to investors who can then judge how likely they are to get their money back in the time allocated.
These ratings are issued by private companies called Credit Rating Agencies.
There are several but the main ones are Standard and Poor’s (S&P), Moddy’s and Fitch. Those 3have about 95% of the global market.
When determining a rating the agency will look at lots of factors that determine if the bond will be repaid. Factors such as the profitability of the issuer, its past credit record, and any asset that the debt might be secured against.
The ratings vary but generally are: AAA (commonly known as triple ‘A’) which represents very low risk, typically issued by high quality institutions all the way down to D (those institutions that have already defaulted).
Current Account: See also Current Account Deficit.
A country’s Current Account represents the difference between what it earns from exporting and what it spends on imports.
There are two parts to this: visible imports and exports which are physical goods such as cars and invisible imports which could be services such as financial services or tourism – both of which involve overseas buyers.
For example, say a tourist from America comes to the U.K. and spends money – that is recorded in the British current account as an invisible export.
The difference between exports and imports is known as the balance of trade.
If exports exceed imports, the country is running a trade surplus. A trade deficit is when a country’s imports exceed its exports.
Current Account Deficit: See also Current Account.
The difference between a country’s exports and imports is known as its balance of trade.
If exports exceed imports the country is running a trade surplus.
A trade deficit is when a country’s imports exceed its exports.
Despite the fact that Britain exports a lot of expertise in the service sector it still runs a current account deficit.
The outflow of money caused by Britain’s current account deficit is balanced by capital inflows from foreign investors in British assets.
Cyclical and Defensive Companies:
Cyclically Adjusted Price/Earnings Ratio:
The Price/Earnings Ratio (PER) is one of the most common methods of valuing a company or market.
It is derived at by dividing the current share price and dividing by the current, or forecast, earnings per share (EPS).
It is generally considered that the lower the PER the cheaper the share.
But there is a flaw to this way of analysis.
The current level of profits for that company may not be a true representation of what the company makes every year. Profits in many companies are cyclical which means they can move up and down depending on how the economy is fairing.
Therefore, a PER may be misleading if wrong profits were used in its calculation.
It is therefore considered more accurate to take profits over a given period, usually 7 to 10 years. By doing this it averages out the profits made by a company to take account of the business cycle.
The share price can then be divided by this cyclically adjusted P/E (CAPE) which indicates if the shares are cheap or expensive compared to the longer average.
Companies are often categorized by analysts as either cyclical or defensive.
Cyclical companies tend to see their profits move sharply up or down in line with how the economy is doing. Profits are good when the economy is expanding, and fall off when the economy is contracting.
Examples of cyclical companies are chemicals, car manufacturers, etc. They tend to have a lot of fixed costs which they have to pay regardless of their sales – hence their profits vary depending on the economic climate.
Dark Pools are private stock exchanges where information is not readily disclosed like normal exchanges.
They are run by big investment banks, such as Barclays and are popular with large institutional investors like pension funds.
The advantage for the large investors is that they can deal in large numbers of shares without the price moving against them.
They are also cheaper.
They have been criticised as being unfair to the smaller investor because the amount of trading actually going on is not available to private investors.
DAX: The DAX, sometimes called the DAX 30 index, is the benchmark stock trading index of Germany. The DAX is different to all other major indices in that it takes re-invested dividends into account. Most other indices measure only capital gains.
If a government spends more than it raises in taxes (i.e. it is running a fiscal deficit) it has to borrow money by issuing debt. For example, gilts in the open market.
Debt Monetisation is what happens when a country’s central bank prints money instead to buy this money.
Defensive companies don’t tend to depend on what’s going on in the whole economy.
They are usually found in industries whose products are needed, such as food retailers, pharmaceutical companies, water companies.
Alcohol products and tobacco products generally witness stable demand.
Shares in Defensive Companies are durable during hard times but not so much in demand when investors are looking for growth stocks.
Ocassionally, investment trust shares trade at a discount to their Net Asset Value (NAV).
That is, the total value of the investment trust’s portfolio of investments is more than the total market value of its shares in issue.
Investors may want to snap up shares that are priced below their real worth.
Conversely, shares may trade at a premium meaning that they trade for more than the value of the underlying portfolio.
For example, a trust may be trading at a 10% discount which means that an investor could buy £100 of assets for only £90. But, there’s no guarantee the discount will shorten. The best advice is to check the historical data to see what is typical and if this ever changes.
Discounted Cash Flow (DCF):
Money promised to you today is worth less than any money received tomorrow.
If you were to invest £100 at an interest rate of 5% then in one year you would have £105
This means that the “future value” of £100 in one year is £105.
Or you could reverse this and work out the “present Value.” If you wanted £100 after one year then you would need to invest £95,2 (the amount that would grow into £100 in a year’s time).
The interest rate is known a the “discount rate.”
You would pay a sum of money today, for the right to receive a sum of money in the future.
You need to know the present day value as explained above.
DCF then is just a method of working out how much a share is worth based on the present or discounted value.
One of the advantages of a company having a stock exchange listing is that the company can raise cash.
This is done by issuing new shares. Usually a Rights Issue.
Existing shareholders are given the right to buy new shares in the company as a proportion to their existing holdings.
For example, if a company announced a two for one rights issue, each shareholder would have the right to buy 2 new shares for every one that they already owned.
If a shareholder doesn’t want to sell his shares he has the “right” to sell the rights. This is known as nil paid (because the shareholder will not have paid anything for them).
Rights issues re usually prices at a discount to the share price (in order to encourage shareholders to take them up).
A large discount is known as a deeply discounted offering, which may be common if a company needs the money.
Alternatively, if the company is not desperate to raise the money (e.g. to pay off debt) it may offer only a small discount. An example of this may be if the company wants to acquire another i.e. takeover.
Receiving a dividend payment is a secondary benefit of owning a share in a company. But dividends are declared one year and cancelled in another. So, how do you give yourself the peace of mind knowing that the company you are invested in will actually pay a dividend?
You can check what the company’s Dividend Cover is.
You can calculate a company’s Dividend Cover by dividing the company’s Earning Per Share (EPS) by its dividend per share and this shows how many times the company’s profits cover the dividend.
For example, if a company has Earning Per Share of 40p and pays a dividend of 10p the dividend is covered four times.
Another way to express dividend cover is using what is called the Payout Ratio. This is the proportion of profits that are paid out as dividends. In the example above the Payout Ratio would be 25%
But … companies with low Payout Ratios can sometimes be unreliable. The argument being that companies may well have profits but dividend safety based just on profits can be dangerous. Profits can’t always be turned into cash and that could spell a problem for making dividend payments.
A better way to assess a company’s ability to pay its dividend is to look at the company’s Free Cash Flow (FCF).
Dividend Cover/Payout Ratios: see also ‘Dividend Cover’
Diversification is process of dividing your wealth amongst various investments so that you avoid being too dependent on any single investment.
If you only own one stock then you are dependent on the success of that one stock.
But if you own say, 15 different stocks, and one or two of them perform badly, then the others should help to compensate. This would be especially true if they were balanced across different sectors of the economy.
Gold will do well in times of uncertainty, Bonds will perform well when inflation is falling, and stocks will do extremely well in times of economic expansion.
Dollar-Cost Averaging: See also "Pound Cost Averaging
Company shares are usually referred to as ‘Ordinary’ shares (in the U.K.) or ‘Common’ stocks (in the U.S.).
The shareholder has a part-ownership of the company and therefore the right to vote on various issues, such as election of board members or whether to accept a bid for the company, and of course, a share of any dividends payable.
However, some companies issue other classes of shares that have different terms and conditions. These are known as ‘Dual Class’ stocks.
One class may carry the rights as described above but the other class has fewer, or perhaps no rights at all.
This is common among US tech firms where the founders want to list the business but without surrendering control. One example of Royal Dutch Shell which has two classes of share, ‘A’ and ‘B’
Preference shares are a mixture of shares and bonds. The owners have first call on any dividends paid, and are higher in the pecking order of creditors. A downside to Preference shares is that their dividend is fixed – they will not see any rise in future dividends.
‘Redeemable’ shares can be bought back by the issuer, either on a certain date or at the issuer’s discretion. They are often used in employer schemes where management want to give staff a stake in the company but if the employee leaves, they have to give up the shres.
Durable Competitive Advantage:
Duration is a measure of risk related to bonds. It describes how sensitive a given bond is to movements in interest rates.
For example, if interest rates go up, bond prices go down.
Duration tells you the likely percentage change in a bond’s price in response to a 1%change in interest rates. The higher the Duration, the higher the ‘interest rate risk’ of the bond
Duration also shows how long (in years) it will take for you to get back the price you paid for the bond.
If a bond has a duration of 10 years, that means you will have to hold it for 10 years to repay the original purchase price. It is indication that a 1% rise in interest rates would cause the bond price to fall 10%.
Zero coupon bods (bond that don’t pay any income), the Duration is always the remaining time to the bond’s maturity. For interest paying bonds, Duration is less than maturity.
Earnings Yield (EBIT/EV):
This is a ratio that compares a company’s earnings before interest and tax (EBIT) and also known as trading profits with its enterprise value (EV) – which is the market value of the company’s equity, plus its debt, and minus its cash.
This gives an Earnings Yield for the whole business expressed as an interest rate.
The higher the interest rate the cheaper the share.
EBIT/EV is a good indicator. It gives information about what an investor pays for the assets of a business and the profits produced from them.
Analysing a company with just a price/earnings ratio is not as good an indicator. Because debt can make shares look cheaper on a p/e basis i.e. shares can look cheap when in fact they are not.
But, it is not a good indicator for financial companies, such as banks and insurance companies.
EBITDA is an acronym for: Earnings Before Interest, Tax, Depreciation, and Amortisation.
Quite a mouthful!
It is however, widely used when scrutinising balance sheets.
It is a way of comparing different company performance and valuation.
EBITDA shows company profits before factors such as depreciation and amortisation (which are difficult to compare between companies) are taken into account.
It is a useful, but not perfect analysis tool. Like all indicators, it is best used, not in isolation, but together with other indicators, such as Free Cash Flow.
Economic Moat: See also Moat.
“Moat” is a word conjured up by Warren Buffet as an analogy to castles.
An Economic Moat is a company’s ability to withstand competition for its products, services, and brands.
The wider the Moat the bigger the company’s competitive advantage.
One of Warren Buffet’s philosophies is to buy companies with big Economic Moats.
Economic Moats mean different things for different companies. For example: company A may sell its products at the lowest price. Company B may have a patent on some technology or process. Company C may have strong brands.
Finding companies with large Moats is to observe their financial track record.
Stable growth, high profit margins, and high ROCE are all signals for such companies.
Shares in companies with big Economic Moats can be expensive. The strategy is to pick them up on dips in the market and hold them.
Emerging Markets is a phrase used, originally by the IMF, to describe less developed countries that are quickly approaching full development status.
There is no exact definition of what an Emerging Market is.
Index provider, MSCI covers 23 markets in its Emerging Market index.
These are countries such as Brazil, China, South Korea, India, Russia, South Africa, Taiwan, and the UAE (which is actually richer than the UK in terms of real GDP per head).
MSCI reviews its lists annually. Israel and Greece have recently been upgraded from Emerging Markets to Developed Markets but Greece was recently downgraded due to the Eurozone situation.
Frontier Markets are those that have not yet reached Emerging Market status. MSCI currently has 21 countries in its Frontier Index, countries such as Bangladesh, Nigeria, Kuwait and Jordan.
Equity Risk Premium:
Equity Risk Premium is the amount by which returns on shares exceed the returns on bonds – over the long term.
It seems obvious that the return on shares should exceed that on bonds because investors expect a higher return because investing in shares is riskier than investing in the safe haven of bonds.
Equity Risk Premium is usually calculated using historical data.
This website is all about investing100% in shares and nil % in bonds.
To illustrate the principal, take the US market which, during the years 1900 to 2015, returned 6,4% per year after inflation has been accounted for.
Conversely, government bonds returned a real 2% during the same period.
This equates to an Equity Risk Premium of 4.4%
Will history repeat itself?
The rest of the world thinks not. The Equity Risk Premium for the UK in the same period was 3,6% and for the rest of the world (excluding the US) was 2,8%
The US tends to be a special case, different from everyone else.
So, what will the Equity Risk Premium be for the next few decades?
Answer: nobody knows. Investing in shares is risky. But our guess would be 5%
Equity To Asset Ratio:
The Equity-To-Asset ratio is the proportion of assets that can be attributed to shareholder equity.
It is calculated by dividing the shareholders’ funds by the total assets.
If a company’s total assets are £100m and shareholders’ equity is £70m then the ratio is 0,7
Which means that shareholders have contributed 70% of the assets and creditors have contributed 30%
The ratio is a measure of the financial strength of the company.
The higher the ratio, the stronger the financial position.
A low ratio might imply a hefty debt. Which means that more income has to be used to pay that debt.
Ratios vary between sector and sector.
Like all indicators, it should not be used in isolation. But it is useful in comparing one company to another.
Eurogroup is a monthly meeting of the finance ministers of the countries that have adopted the Euro as their official currency.
The Eurogroup has around 19 members. It first met on 4th. June 1998.
The group is the main forum for discussions about political matters related to the running of the European monetary union and the Euro.
The Eurogroup is informal and was given legal status by the Lisbon Treaty in 2009.
Exchange Traded Funds (ETP):
Exchange Traded Products (ETPs) are investment funds that an investor can buy or sell in exactly the same manner as shares.
ETPs are mostly passive investments which means that they aim to track the performance of a particular market rather than try to beat it.
N.B. Active funds do try to beat their markets.
Exchange Traded Products (sometimes called: Exchange Traded Funds) are available in a range of indices, sectors, investment themes and commodities.
ETPs are available in two types: physical and synthetic.
A physical ETP invests in the assets that it is supposed to track. For example, a FTSE-100 ETP will invest in FTSE-100 companies.
A synthetic ETP agrees a swap with a third party.
Physical ETPs are preferred by most investors and trading in synthetic ETPs is rare.
Physical ETPs are regarded as simpler than their synthetic counterparts and synthetic ETPs are hardly invested in by the ordinary investor.
The Ex-Dividend date is used to determine which shareholders are entitled to receive the dividend payout.
If an investor were to buy a share before it goes Ex-Dividend, i.e. before the close of trading the day before the Ex-Dividend date, then the investor is entitled to the dividend payout.
In an investor buys shares on or after the Ex-Dividend date, then he won’t get the next dividend. The previous owner will be entitled to it.
Take an example: if GSK goes Ex-Dividend on 6th June and an investor sells his shares on the afternoon of 5th. June the new buyer will be entitled to GSKs next dividend payout.
However, if the seller waits until the morning of the 6th June before selling, then he will be entitled to the dividend and the new buyer will be entitled to nothing.
Before trading became computerised, it took time to up-date the shareholders register and mistakes were made. On many occasions, dividends were paid to the wrong recipient and monies had to be re-paid.
Share prices usually drop on the day the day they go Ex-Dividend. Usually by the amount of the dividend being paid. Depending on market conditions that day, the shares may rise, or fall, in addition to the Ex-Dividend price drop.
Electronic trading platforms adjust prices to take account of this.
Fidelity Personal Investor:
Financial Gearing is the sensitivity of a company’s profits to changes in sales.
It is the amount of debt a company utilises to finance its business compared to shareholders’ funds.
But, debt has its costs – interest. Interest has to be paid before shareholders get their dividend payments.
For example, a company with no Financial Gearing that grows its profits by 10% from £100m to £110m (produces after-tax profits from £80 to £88m with tax at 20%).
But if the company had debt, costing £20m a year interest.
If the company still makes a 10% increase in profits, tis leads to a 12,5% increase in after-tax profit (after interest payments, profits rise from £80m to £90m) the riskier are its shares.
Assuming the same 20% rate of tax, the after-tax rise in profits is £64m to £72m.
However, Financial Gearing works both ways. If the company makes a loss, these are magnified too. The more Gearing a company has,
Fixed Charge Coverage:
Part of researching a company you may want to invest in is knowing if it makes enough profit to cover its Fixed Charges.
These Fixed Costs are what the company has to pay regardless of how much business it does, or doesn’t do.
Rents and interest charges are Fixed Costs.
The Fixed Charge Coverage ratio is best used on companies that rent assets e.g. equipment and properties.
High street retailers are good examples.
For example, a company has trading profits of £100m, rents of £50m and interest payable of £20m.
Rents get charged before trading profits so the Fixed Charges are £100m plus £50m = £150m.
The Fixed Charge Coverage ration is therefore: £150m/(20 + 50) = 2,14
In this example the company appears to be “safe” enough. Hover, if the Fixed Charge Coverage were to fall below 1,5, this could be a warning sign.
FTSE 100: The FTSE 100, affectionately known as "Footsie," is made up of blue-chip companies. Total constituents of this index make around 70% of their sales overseas. A much better guide to the UK market is the FTSE All Share index.
FTSE 250: The FTSE 250 is a more accurate representation of the UK market than the FTSE 100. It is comprised of mid-cap stocks and earn 55% of their sales in the UK.
FTSE ALL Share:
Free Cash Flow (FCF):
Free Cash Flow (FCF) is a measure of a company’s ability to generate spare cash. It is the money left over after all expenses have been paid.
This money can be returned to shareholders or used to reduce debt.
There are different ways to calculate FCF but the most common is to profits before interest payments, add depreciation and amortisation (allowance for depreciating assets) and remove any capital expenditure.
Depreciation and amortisation can be manipulated.
There are two schools of thought on FCF. One argues that FCF gives a truer picture of how a company is doing whilst the other argue that a rapidly expanding company may have a low FCF but could be better in the long term.
Companies are not obliged to provide a figure for FCF but it is easily calculated from information in the annual accounts.
Free Cash Flow Yield:
Some investors don’t trust profit figures in company accounts.
They think that creative accounting, such as valuation of assets or timing of revenues can skew the figures.
They think that valuing a company with just its earnings per share (EPS) or price/earnings ratio (P/E) doesn’t make sense.
They think a company’s Free Cash Flow, which is the actual money that’s left over after all expenses have been paid for is a much better indicator. Their argument being that it is far more difficult to fudge a cash figure.
The Free Cash Flow Yield can be calculated by taking the company’s Free Cash Flow and dividing it by its market capitalisation or by dividing the Free Cash Flow per share by the current share price.
Companies with high Free Cash Flow Yields are targets for takeovers.
Free Cash Flow Yield may also be compared with the Dividend Yield as a measure of how safe the dividend payout is going to be.
The word ”Future” goes back to ancient times.
Farmers would take their wares to market and sell them at the going rate (known as the spot price).
But they never knew how much they would make until they got to market so they began selling at a given price before they got to market, and promised to deliver the goods in the future.
In today’s markets you can buy for a wide range of assets – financial and commodity based.
Investors use futures for hedging and for speculation.
For example, an investor could buy a future contract in say, the FTSE-100 at 8,000 at a future date and hope that by the time it falls due (or any time before) the market will have risen.
Futures have leverage which means that the investor would buy at a percentage of the initial price.
Futures are usually settled financially and no delivery of the actual instrument is made.
Gearing: See also Financial Gearing
A “Greenspan Put” was a phrase used after the 1987 stock market crash.
Alan Greenspan, was, at that time the Federal Reserve chairman.
He reduced interest rates every time the market had a sharp fall.
A “put” is a financial instrument that enables you to insure against market falls.
This action encouraged ordinary investors to take on more risk than they would have ordinarily done so.
All this aggregated action could work against the central banks that are trying to stabilise it.
Halifax Share Dealing:
Hang Seng: The Hang Seng index is the benchmark stock trading index of Hong Kong. And here it is financials that hog the index accounting for over 50%.
James Hay Module Plan:
The term “Hedge Fund” was first coined in the 1950s.
Back then it referred to funds that used investment strategies such as buying individual stocks and shorting the broader market.
However, in today’s markets the term Hedge Fund is used for a wider range of funds that use a larger number of strategies which may not involve any hedging at all.
Hedge Funds are not cheap. A typical charge is known as “two and twenty.” A 2% annual management charge and 20% of any profits.
Statistics show that the average Hedge Fund significantly underperforms a well balanced portfolio of stocks.
The latter of which is strongly advocated on this website.
Most takeovers are agreed. These are usually called Mergers.
Takeovers occur when a company make an offer for all of the shares of another company.
The bidding company asks the directors to recommend its offer to the shareholders. If they agree to the offered price, the takeover will go ahead un-opposed.
However, occasionally, the company directors of the company being bid for may consider the offer undervalues their company and do not recommend the offer.
If the bidding company still wants its target, it will contact the shareholders directly and put to them the bidders proposals for the company.
Once the bidder obtains a controlling interest in the target company, it can then force the remaining shareholders to accept the bid.
The target company will also try to defend itself by making promises to shareholders. It can also happen that the target company tries to buy the bidding company. This is known as a “pac-man” defence.
Hostile Takeovers became common in the US and the UK during the 1970sand 1980s.
IBEX 35: The IBEX 35 is Spain's benchmark stock trading index. Financial companies account for around 42% of the index. Such a heavy weighting of financial stocks is around twice as much as other major European stock markets.
Initial Public Offering (IPO):
Initial Public Offering (IPO) is the first sale of shares in a company.
There are two common types of IPO. One is via a placement whereby a bank acting on behalf of the company attempts to sell shares to institutional investors.
Another method is to offer shares to the public – hence the term: “Going Public.” Another common term used is “floating on the Stock Exchange.”
IPOs are usually underwritten by a stock broker who agrees to buy any shares that are not taken up by the public.
IPOs are most commonly associated with young, growing companies, who are looking for extra cash in order to grow and strengthen their business.
Sometimes IPOs are a means for the owners to raise cash for their own private means i.e. they want to cash in on what they created.
International Monetary Fund (IMF):
The IMF is an international organisation that has a central role in managing the global financial system.
It was founded in 1945 in an effort to rebuild global trade after the Great Depression and World War II.
Since then it has expanded enormously.
It describes its purpose as “working to foster global monetary co-operation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world.”
The IMF has 188 member countries. Each of which has a quota which defines several things: the maximum financial commitment to the IMF, how much it can borrow, voting power.
Quotas were set when each country joined but western, powerful economies have a heavy proportion of control compared with emerging markets.
If a company, or a government, wants to rise money it will issue bonds.
Bonds issued will be given a credit rating by credit rating agencies. These ratings are a guide as to how risky the bond are. In other word, what’s the likeliness of the company, or government, being able to pay back the debt? This would be known as defaulting.
Junk Bonds are those bonds that have been given a credit rating of BB or less.
A Junk Bond may have been given a BB (or less) rating because it already has a lot of debt. Or, it operates in a cyclical industry where its earnings are unstable.
Thus, the repayment of the debt may be risky.
Junk Bonds are also called “non-investment grade” bonds and also known as high-yield bonds. Junk Bonds have to offer a higher rate of interest than safer bonds because of that added risk.
Investors make money from Junk Bonds if a company’s performance improves and they also make money if interest rates fall.
John Maynard Keynes:
Kospi: The Kospi is South Korea's benchmark stock trading index.
Cyclical stocks make up about 80% of the index. Industrials and technology stocks account for over 38% and 16% of the index.
Leverage: See also Gearing.
Leverage is using debt to fund an investment. It is sometimes referred to as gearing.
It is a technique that can make handsome returns but equally return hefty losses.
Lifestyle Investing refers to how much time an investor has left to save and how much risk he is prepared to make.
Someone in their 20s who plans to retire at age 65 (or there abouts) can afford to have more of their investments in risky assets, such as shares.
However, someone in their 50s (or even older) may think they should have their life savings in less risky assets, such as cash or bonds.
There are such things as Lifestyle Investment Plans that are offered by investment companies.
I personally do not advocate this kind of investing. It wouldn’t fit my philosophy.
Many advisors “advise” their clients to invest a proportion of their portfolio in cash and bonds in proportion to their age. So, for example, someone aged 30 would invest 30% of their portfolio in cash and bonds, and the rest in equities. This would translate to someone who is 50 years old changing his investment mix to 50% cash and bods, and 50% equities.
I think such thinking is a load of cobblers and clients who follow this advise would miss the opportunity of growing tens of thousands of pounds (or dollars) in their portfolios.
Sadly, there is a lot of such negative thinking.
History has proved that being fully invested in equities has its rewards.
Liquidity is the ease in which you can buy or sell an asset without moving the price against you.
Shares in big companies, such as those listed in the FTSE-100 (“Blue chips”) are very liquid. You will get a price instantly and you will always find a buyer or seller – even in volatile times.
Stocks in smaller companies can be very illiquid. When markets are volatile, the “spread” (the difference between the quoted price to buy and sell) may widen substantially.
Property is also an illiquid asset. You cannot buy and sell immediately, it takes time. If you want to sell in a hurry you may have to lower your price well below market value.
Should panic strike markets, the only really safe havens for your money would be government bonds (US Treasury or UK Gilts)
London Interbank Offered Rate (LIBOR):
LIBOR is an acronym for "London Interbank Offer Rate.”
LIBOR is a Sterling interest rate that leading banks of the world charge each other for short term loans.
The Intercontinental Exchange (ICE) fixes LIBOR rates on a daily basis.
The rate is an important guide to the strength of the banking sector.
Other currencies offer similar benchmark rates such as the US Dollar and the Euro.
Margin of Safety:
This term originates from Benjamin Graham – the father of Value Investing and mentor to Warren Buffet.
Margin of Safety basically means that you should only invest when you can buy for a lot less than its “intrinsic value.”
Intrinsic Value being what an investment is truly worth.
That leaves a gap between what an investment is really worth and what you pay for it. This is called the Margin of Safety.
As an example, consider a share whose intrinsic value is 200p and using Margin of Safety of about 25% (typical), then you should only be paying around 150p for that share.
See Net Asset Value (NAV) for how to find the intrinsic value of a share).
If no such share is available then you need to wait until prices fall, and then fill your boots.
A stock’s Market Capitalisation is its overall market value.
It is calculated by multiplying the share price by the number of shares in issue.
Companies can be categorised in accordance with their Market Capitalisation. Companies can be defined as Large Caps, Mid-Caps, Small Caps, and Micro-Caps.
Large Caps, in the UK, are generally valued over £4bn and are FTSE 100 constituents.
Mid-Caps, are usually constituents of the FTSE 250, with market values between £500m to £4bn.
Small-Caps generally are between £150m to £500m
Micro-Caps are valued somewhere from £150m downwards.
Micro-Caps are less liquid and therefore riskier than larger stocks. They are harder to buy and sell and less covered by analysts.
Mark to Model:
Mean Reversion is an theory that, over the long term, everything tends to revert to its long-term average, or mean.
As an example, say house prices tend to move towards a longer-term ratio of prices to average incomes. Or share prices tend to move towards a level of valuation.
Prices may move away from the long-term average in the short term, but eventually, the effect of Mean Reversion will pull them back towards the mean.
The concept is helpful for investors as it may suggest when prices are abnormally high or low.
Schiller’s price/earnings ratio (the Cape or cyclically adjusted p/e) is a well-known example of Mean Reversion.
History has shown that when the Cape is well above average, the market is expensive.
When the Cape is well below average, the market is cheap.
Microcap: See also Market Capitalisation
The term Minority Interest is accountancy jargon that describes the part of a company that is owned by outside shareholders.
Take an example: a company buys 80% of another company which ha assets of £100m
The assets of this second company (called the subsidiary) must be fully consolidated into the accounts of the parent company.
The full £100m of the subsidiary’s assets are added to the parent company’s balance sheet. But, 20% of those assets belong to other shareholders.
Accountants show this by including £80m in the shareholders equity. The other £20m listed separately as a Minority Interest.
Profits of the company are dealt with in the same way.
Moat: See also Economic Moat
An Economic Moat refers to how well a company can withstand competition.
If the Economic Moat is wide, the bigger the advantage the company will have over its competitors.
Part of Warren Buffet’s success is built on buying companies with exceptionally wide Economic Moats.
Not all Economic Moats are not the same. But they do have one thing in common – they tend to be expensive and as such, they could not be a good investment, but, they can also be picked up cheaper whenever there is a market downturn or crash.
Economic Moats typically make it difficult for competitors to “muscle in” ad take away their customers. Their Moat may be that they have a patent on some technology or process.
They may have strong brands (e.g. Coca-Cola/Pepsi). Or they may be the cheapest.
Spotting a company with a Moat is fairly easy. Look at their financial record over the years. Are there growing profit? High profit margins? High returns on capital employed, ROCE?
Then the big question is: can this company keep its Moat?
A Moving Average is a term used by Technical analysts.
A simple price chart is not informative enough. It needs more information. Furthermore, a simple price chart is too volatile.
A Moving Average “smoothes out” the volatility of the simple price chart.
Take for example, a week of a share trading. Its closing prices for that week are: 100p, 102p, 110p, 112p, 115p.
The average of those 5 days would be the sum of the above divided by 5 which equates to: 539/5 = 107,8
Now consider this, on the next trading day the share price falls to 106p.
The 5-day Moving Average is now: 109p
The next day’s trading sees the share price fall further to 98p. The 5-day Moving Average I now: 108,2p
The next day’s trading closes at 94p. The 5-day Moving Average is now: 105p
A graph of the share price (the simple price chart) can be drawn and super-imposed on that can be the 5-day moving average.
It will be seen that the moving average begins with an up-trend but gradually reverses to show a downtrend.
Normally, Moving Averages of 21-days, 34-days, 55, days, and 200-days. All these numbers, except the 200-day average, follow the Fibonacci sequence.
Take for example, the Dow Jones Index. A short-term Moving Average to use here could be the 55-day with a longer-term Moving Average of 200-day.
When the 55-day average begins to trend upwards, it can be an early sign that the index is ready to rise, or ha already begun its rise.
It will take longer for the 200-day average to trend upwards, but when it does, it is regarded as a very strong signal to be long of the index.
When the 55-day average crosses the 200-day average it can be taken as a strong buy signal. This is known as the “golden cross.”
There are generally two reasons why a share price increases in value.
The first is that company profits may be rising thus making the share attractive to investors.
The second reason is that investors tend to “pile in” when they hear of shares that increased earnings and therefore an increasing P/E ratio.
This effect is known as Multiple Expansion.
When P/E ratios are falling, the effect is known as Multiple Compression.
High P/E ratios suggest that prices may be getting too pricey and demand tapers off. Then a risk of Multiple Compression takes over.
Net Asset Value (NAV): See also “Book Value”.
The Balance Sheet of a company shows what it owns(its assets) and what it owes (its liabilities).
Assets – Liabilities = Net Asset Value or NAV
If the NAV is divided by the number of shares in issue to arrive at the NAV per share.
NAV may also be called Shareholders’ Funds or Value of Equity
NAV can give a rough idea of what a company is worth if everything was sold off and all its liabilities were paid.
However, the valuation in the company accounts and their true market value may not be the same. This is because NAV contains “intangible assets” which are difficult to put a true value on.
In tangible assets could be things like value of a brand, or goodwill.
Private investors looking for a bargain share often search for companies whose NAV is greater than the actual share price. NAV is only a rough guide to a what a company is truly worth. Investors must do a lot more due diligence than finding a companies NAV.
Net Asset Value of a Fund:
Open Ended Investment Company (OEIC):
Open Market Operations (OMO): See also Quantative Easing (QE)
When a country’s central banks buy or sell securities to control interest rates the process is called Open Market Operations (OMO).
OMOs differ from QE insomuchas the deal in short-term transaction in short-term bonds, whereas QE deals with long-term holdings of longer-term bonds.
Operational Gearing: See also Financial Gearing and Operational Leverage.
Operational Gearing is a term used to describe how sensitive a company’s trading profits are to changes in its sales.
For example: a company with high fixed costs, such as staff and premises. Such costs have to be paid for regardless of any sales made. Such companies are termed highly geared.
But a company that has variable costs, its gearing will rise and fall depending on the sales that it makes.
Take a company with sales of £200m. Its fixed costs are £150m and its variable costs £20m. That leaves £30m profit (before tax etc.)
If its sales rise by, say 10%, to £220m, the fixed costs stay at £150m, but the variable costs increase by 10% to £22m.
The trading profit is now (£220 - £150 - £22) = £48. That’s over 50% increase.
Take another company with the same sales of £200m, fixed costs of £100m and variable costs of £50m (giving a profit of £50m) then a 10% rise in sales would push variable costs up £5m which would give a profit of £65m about a 13% increase.
This last example being a lowly geared company.
Now, suppose, sales fall by 10% at both companies.
The highly geared company would have its profits wiped out, or nearly wiped out.
But the lower-geared company would still make a profit.
When times are good, companies with high Operational Gearing can be very profitable. But when times are not so good (i.e. a Bear Market) they can be a very risky investment.
Operational Leverage: See also Operational Gearing above.
Operational Leverage relates to how sensitive a company’s trading profits are to changes in turnover.
Some companies have very high fixed costs e.g. salaries and premises.
These are called companies with high Operational Leverage.
On the other hand, companies that can be described as having low Operational Leverage, have low fixed costs and variable costs that depend on turnover.
Typical companies with low Operational Leverage are internet retailers.
Private investors who buy companies with high Operational Leverage can be very profitable in Bull Markets but very risky in Bear Markets.
Furthermore, companies that have a lot of borrowing in relation to shareholder equity also have high Financial Gearing.
Companies with high Financial Gearing and high Operational Leverage are a toxic combination. Beware!
Overtrading can be defined as:
capital required/capital available
Capital required is a measure of how much capital a business needs to operate properly.
E.g. pay for premises, staff, fixed assets, stock
Capital available is the total of shareholder funds, retained profit, loan capital, director loans, and any other funding for the company
Overtrading means that the company is over capitalized
Overtrading is more serious than Undertrading. It usually means that it has insufficient stock to fulfill its orders and insufficient staff to carry them out.
Overtrading can also be noticed from other financial ratios:
1. The current Ratio is likely to be low
2. The Turnover Ratio is likely to be high
3. Creditor days are likely to be high
4. Debtor days are likely to be low
Overtrading is considered serious if a company’s Overtrading Ratio is more than 2.
Pairs Trading is a strategy where you simultaneously bet on one asset going up in value and at the same time bet on another asset to fall in value.
That is, you would go “long” on one asset and “short” the other.
Companies that operate a ‘defined benefit’ or a ’final salary’ pension plan can suffer from a Pension Deficit.
They both promise to pay their staff a set income during retirement.
‘Defined contribution’ plans place all the onus on the individual. They have to make sure that their ‘pension pots’ grow enough to fund their retirement.
Defined Benefit and Final Salary pension plans have assets and liabilities. If the liabilities are greater than the assets, the plan has a deficit.
In such cases, the company has to make up the deficit. This could take years.
In the 1980s, Ronald Reagan’s government wanted to reduce inflation. This was effected by allowing the Federal Reserve to increase US interest rates.
People then wanted to buy dollars in order to take advantage of this rate rise. Thus pushing up the dollar’s value.
Tis caused problems for US businesses because US goods were made more expensive on world markets. Conversely, imports became cheaper.
In order to avoid a trade war, the US, the UK, West Germany (as it was called then), France and Japan signed an agreement at the Plaza Hotel in New York in 1985. All these governments agreed to sell dollars to bring down its value.
Over the next two years, the value of the dollar dropped 50%.
However, Japan suffered from a falling dollar and a rising Yen. Affecting badly its exports.
To counteract this, Japan cut interests rates.
This led to a credit boom and price bubbles in the Japanese Stock Market and Property markets.
The Nikkei reached 39,000 in the late 80s it’s now approaching the year 2020 and it languishes in the low to mid 20,000s. A far cry from its peak.
Point and Figure Charts:
Pound-Cost Averaging: See also Dollar Cost Averaging.
Pound Cost Averaging is a strategy whereby an investor invest an equal amount of money regularly (usually monthly).
For example, an investor may invest £1,000 per month in a certain fund. When prices are low, he will be buying more units. When prices are high, he will be buying less units.
But, over time, his savings will be smoothed out.
Essentially, it is un-emotional investing. Buy it and forget it.
This strategy is how most people’s pensions are invested.
Premium or Discount:
A shareholder’s value of a Unit Trust or Open-Ended Investment Company (OEIC) is always the Net Asset Value (NAV) of the fund divided by the number of shares owned.
But a Closed-End Fund or Investment Trust are traded on the Stock Exchange and their shares do not follow the Net Asset Value.
Certain sectors or industries may be out of favour, or investors may think that the stated NAV is not right.
Consequently, the shares of such funds can trade above the NAV or below it.
When the share price is above the NAV the shares are said to be trading at a premium.
When the share price is below the NAV the shares are said to be trading at a discount.
Price Earnings Growth (PEG) Ratio: See also PER just below.
The PEG Ratio is another key number when it comes to a share’s valuation.
It is a comparison of the PER of a company with the expected growth in its Earnings Per Share (EPS).
This ratio is a variation on the PER (see below) and is considered a better indicator then the PER. My advice would be: use BOTH of them plus others.
A PEG Ratio of less than 1 would suggest that a share is attractive.
It can be used as a good tool for comparing different companies in the same sector. For example: one company in a specific sector might have a PER of 14 but could be expected to grow its earnings at a rate of 20%, thus making a PEG Ratio of 14/20 = 0,7 A rival, in the same sector, also has a PER of 14 but is only expected to grow its earnings by 5% giving it a PEG Ratio of 14/5 = 2,8
Clearly, the company with the lower PEG Ration is the more attractive.
But, it is difficult to know what a company’s future growth figures are likely to be. Even full-time analysts get it wrong.
A lot of due diligence is required when researching growth.
Price/Earnings Ratio (PER):
The Price/Earnings Ratio or PER, of a company is calculated as the share price divided by its current Earnings Per Share (EPS).
It is a representation of the value of the company expressed as a multiple of its after tax profits. For example, if a share is trading at 200p and has EPS of 20p then its PER is 10
It is common for analysts to calculate the PER based on an earnings forecast. This is called a “forward PER”
A PER can also be based on historical earnings and would then be referred to as a “trailing PER”.
Forward PERs and Trailing PERs are commonly used to value shares.
The bigger the PER the more expensive a share is seen to be and bigger PERs are common with companies with fast-growing profits.
A low PER on the other hand, can be seen that a share is cheap, BUT it could also mean that the share has gone post growth or prospects are uncertain.
PERs can also be used to calculate a share’s Earnings Yield. A PER of 10 would become an Earnings Yield of 1/10 or 10%
It’s not as simple as to say shares with low PERs (i.e. high Earnings Yields) are a bargain. Many other factors and ratios need to be considered.
The Price/Sales Ratio is a very useful way to conclude whether a company’s shares are cheap or expensive.
It is easier for a company to manipulate its earnings than it is to manipulate its sales. Items can be added to profits and items can be left out of profits.
PSR is calculated by dividing a company’s Market Capitalisation by its annual sales (revenue).
The ration is an indication of how many years it would take the company to sell its goods to the value of its market capitalisation.
A PSR of 4 would show that it would take the company 4 years.
A PSR of less than 1 would suggest the shares are cheap.
The ration is especially useful for comparing young companies, e.g. those that have not yet achieved earnings but do have sales.
Price to Book Ratio: See also “Book Value”
Book Value may also be referred to as Equity, Shareholders’ Funds, or Net Asset Value (NAV).
In short, it is the value of all a company’s assets less all of its liabilities (debts).
This number can be found in the company balance sheet which can be found in the company’s annual report.
Book value is sometimes used by investors as an estimate to what a company is worth were all of its assets be sold for figures as shown in the balance sheet.
However, as usual, it’s not that simple.
Book Value in a company’s account may contain a lot of “intangible assets”. Intangible assets are things like goodwill (usually the value of a “brand”).
If the intangibles were not included in the calculations, the new value would be known as “tangible assets.” The figure in the accounts could then be called “Tangible Book Value.”
Tangible Book Value would then refer to actual hard assets such as cash, stock, land, buildings, machinery.
If this figure is then divided by the number of shares in issue you would have the tangible book value per share. And if you could buy shares for less than this figure, you may have found yourself a bargain.
Private Equity is money that is not listed.
A private equity company has raised all its capital from institutional investors or wealthy private individuals.
Private Equity companies try to buy companies that are underperforming. They can commit massive funds and expertise in order to turn companies around.
They make their money if the companies ever make a profit or selling it if they turn around enough for them to take public.
It is a rule of Stock Markets that their members must notify, in a timely manner, any news that might affect the share price.
This move is to stop “insider” traders hearing the news first and taking advantage of any imminent change in the price of the company’s shares.
Some events that might be sensitive to price change would be director dealings, changes in management, news of a merger/takeover, etc.
One event that is common is that of company profit forecasts.
Stock Markets rule that they must be notified of any major changes in the company’s circumstances.
Sometimes companies deliberately remain silent. It’s not a good idea!
Profit warnings are common.
Most companies want to get the “bad” news out of the way as soon as possible in the hope that by doing so it will lessen the market’s reaction.
To amateur investors, Profit Warnings present ideal buying opportunities. But there is a old City saying: “Profit Warnings come in threes.”
Put Option: See also – Call Option.
Options can be dangerous for the un-initiated.
Options give you the right to buy, or sell, something (usually shares). They can also be used in hedge strategies.
A Put Option gives the purchaser the right, but not the obligation, to sell a share (or other financial asset).
You would probably buy a Put Option if you thought the share was likely to fall in value and as such, make a profit.
Option contracts are sold in blocks of 1,000 shares.
For example: if a company is trading at 120p per share and a Put Option, gives the right to sell at 110p and costs 5p, the cost of the Put Options would be £50 (5p x 1,000).
If the shares were to fall to 90p the Put Option buyer would make a profit of £150 ((110p – 90p – 5p) x 1,000)
If the share were to rise, the Put Option would expire, and the buyer would lose the entire premium he paid of £50.
Quantitative Easing (QE):
Real Estate Investment Trust (REIT): REITS were established in 2007.
They are property companies that invest in commercial properties (offices, warehouses, shops, etc.) and even residential apartments.
It is a novel way for ordinary investors to have a stake in properties within having full ownership.
Many large property companies have converted to Rmainly because of tax advantages.EIT status
Real Interest Rate:
In financial parlance, the word “real” is taken to include inflation.
Conversely, the word “nominal” is understood to exclude inflation.
This is important to understand because interest rates on savings accounts and bonds are usually always quoted nominally.
Which makes it harder to figure out if your savings re keeping up with the rising cost of living.
Take an hypothetical example of £1000 invested into a savings account that pays an annual interest rate of 5%. Simply put, by the end of year 1 you would have accrued a total savings figure of £1050.
But, if inflation during that first year averaged 3% then the buying power of your £1000 would now be £1030. That is, £1000 would no longer buy as much as it did 12 months ago.
Real Interest Rates allow for this drop in buying power.
In our hypothetical example the Real Interest Rate would be 2% (£2/£1000).
Yields on Index-Linked Bonds (or Inflation-Linked Bonds) take into account the rate of inflation and are quoted as such in the media.
Many investors have been advised to balance their portfolio with a mixture of shares and bonds.
Here at Common Sense Retirement Investing we are not great fans of investing in bonds. We prefer 100% invested in shares.
But, for those who do wish to invest in shares and bonds, so-called financial advisors like to have their clients invested 60% in shares and 40% in bonds. Although, even this figure varies with the age of the client and his aversion to risk.
Rebalancing occurs when the ratio of 60% in shares and 40% in bonds gets skewed due to outperformance of the shares element. Say the ration changes to 70% shares/30% bonds.
Cautious investors want (or are advised to) redress the balance of their portfolio in order to bring it back to 60%/40%.
So some shares have to be sold and with the proceeds buy some bonds. This action then restores the 60/40 percentage balance.
Some portfolios address this Rebalancing several times a year although twice a year is enough and prevents paying unnecessary trading costs.
The psychology behind Rebalancing is that it instils discipline to portfolio management.
We here at Common Sense Retirement Investing do NOT advocate this cautious approach. But it all depends on what type of investor you want to be. Rebalancing suits some people.
But not all.
When a public company declares its dividend, it isn’t paid out immediately. Payment can be anything from a few days to a few months.
Active investors may wish to sell their shares during this period. What is known as between declaration day and payment day.
If some investors decide to sell during this period it is then up to the company to decided who is paid the dividend. Companies have to set what is called the Record Date.
Anyone on the shareholder’s register on this Record Date will be entitled to the dividend.
To add further to the complication, shareholders registers are not up-dated immediately. It takes a finite time before trades are settled and new buyers are recorded by the registrar.
That is why the Stock Exchange sets a separate date known as the Ex-Dividend date, after which a share can be sold without the right to be payed the dividend.
The timing of this Ex-Dividend date varies slightly, but is typically two days before the record date.
This is a key measure used by property investors. It is a means for investors on how to decide what to pay for a property.
It is easily calculated as the gross annual rental income divided by the market value.
It is an indication of the income return when buying property at the current price. A prime property with a good tenant on a long-term agreement will have a lower yield than say a remote building not easily rented out.
In other words, yields are inversely related to risk.
High rental yields can be a sign that a property is undervalued.
On the other hand, low yields could indicate that a property is expensive.
Retirement Planning Guide:
Return on Assets:
Another key consideration when deciding what shares to buy is knowing how good its management is at generating profits from existing resources.
ROA is calculated by diving the net profit by total assets (equity plus debt)
The higher the ROA the better.
If a company makes £5m profit and has assets totalling £50m its ROA will be 10%.
By comparison, a company earning the same profit (£5m) but has assets worth £100m will have a ROA of 5%.
The ROA is sometimes referred to as the Return on Investment.
And, like so any ratios, it needs to seen how it varies from one industry to another, and from one sector to another.
Return on Capital Employed (ROCE):
ROCE is one of the most important calculations to make when considering investing in a company.
It examines a company’s trading profit as a percentage of money that is invested in the business.
More simply, money invested in a business is the amount of equity raised plus any loans taken out.
This sum is the total of capital employed that the company is using to generate its profits.
In this calculation, the profits are expressed as a percentage – so the higher they are, the better.
ROCE is a good indicator of how well the management is investing the money it has at its disposal.
ROCE is usually scrutinised over a period of years – typically 5-10 and the trend observed.
However, not all industries and sectors are alike. Cyclical businesses may have a very high ROCE over a short term and low ROCE over the longer term.
ROCE greater than 10% are considered good. But investors would look for ROCE considerably greater than what you could get from a passive investment.
Return on Equity:
Another useful indicator for assessing a company is the Return on Equity or ROE.
Return on Equity compares a company’s post tax profits with the company’s equity (the money invested by the shareholders).
Take a company with post tax profits of £50m and equity of £500m, its ROE would be 10%. Now compare the ROE of a company with £100m post tax profits and £2bn of equity. That company’s ROE would be 20%.
Potential investors would see the second company has made its profits work twice as hard as the first company.
But, as with all financial ratios, the ROE can be mis-leading.
The company may borrow money and debt is not considered in the ROE calculation whereas with ROCE it is.
Why have ROE at all?
Why not just use ROCE?
A big advantage of being a public company is that it is easier to raise money. They can just issue new shares.
Such an issue would be called a “Rights Issue.”
It gets its name from the fact that existing shareholders have the “rights” to buy the new shares in proportion to the shares that they already own.
The Rights are usually priced at a discount to the current share price in order to make them attractive.
And if existing shareholders don’t want to ‘take up’ any new shares, or can’t afford them, they can sell their Rights into the market. This is known as selling the Rights “nil paid.”
To understand the value of the nil paid rights you would need to calculate the Theoretical Ex-Rights Price (TERP).
Phew, another acronym!
The value of the nil paid rights is then the TERP minus the Rights Price.
Investing in general is a risk. But apply what you read on this website and it is a calculated risk.
The higher the risk, the more the expected return.
Although, this website is about Investing and NOT, Speculating. There is a world of difference.
US or UK government bonds are seen as close as is possible to be risk-free. But, as an investor in a company you would expect to be compensated for the extra risk. Investing in a company has got to be more risky than investing in government bonds.
Investors would, of course, expect a better return on their money for taking the extra risk and this is known as “Risk Premium.”
Sale and Leaseback:
Sale and Leaseback is when the seller of an asset agrees to lease it back (i.e. rent it) from the buyer.
Sale and Leaseback is very useful if a company is wanting to raise cash but he doesn’t lose the use of the asset.
For example: supermarkets have sold a lot of premises to real estate companies on long-term leases.
Stamp Duty Reserve Tax (SDRT):
SDRT is an abbreviation for Stamp Duty Reserve Tax. It is a tax levied on the purchase (but not the sales) of shares that are held in electronic form.
SDRT is charged at a rate of 0.5% of the consideration of the shares purchased.
There are a few types of shares that are exempt from SDRT.
SDRT was first introduced in 1986. It was introduced to take the place of the old style Stamp Duty that was levied on paper share certificates.
There are still some share transactions made in paper certificate form and these are subject to Stamp Duty rather than SDRT. Stamp Duty is also levied at 0,5%.
No Stamp Duty is paid on paper transactions on considerations £1000 or less.
A company can return money to its shareholders in the form of dividends. It can also return cash by buying its own shares.
There are several reasons a company may want to buy its own shares.
1. The shares are cheap
2. Tax savings. Companies do not receive tax relief when paying dividends but they do receive tax relief when paying interest. So if a company borrows money in order to buy its own shares it will receive tax relief on the interest of the monies borrowed.
3. If the number of shares are reduced the company’s earnings per share (EPS) should go up. And a higher EPS figure should lead to a higher share price.
The “trick” is that buybacks should be executed at a low share price (i.e. 1. above)
Smart Beta is a term for a wide range of trading strategies whose aim is to beat the market by investing in groups of securities that have out-performed over the long term.
Research tends to suggest that shares that have been rising will continue to do so (aka “Momentum”).
Also, shares that have low valuations tend to perform better than those with high one (aka “Value”).
Smart Beta strategies identify shares that fit certain criteria and then invest in them.
The criteria used (e.g. momentum and value) are often referred to as “factors.” Hence, Smart Beta may sometimes be referred to as “Factor Investing.”
Short Term Trading:
Special Drawing Rights (SDR):
SDR is an international reserve asset that was created by the International Money Fund (IMF) in 1969 and based on the US Dollar. Today, they are based on a basket of currencies – the $, the £, the Euro, and the Yen, and the Chinese Yuan.
It was designed to supplement the official currency reserves of member countries.
SDRs were designed to be a resource for member countries that are running out foreign currency reserves to be able to exchange with other member countries.
This exchange of SDRs for currency can be done between member countries.
Spread: See also Yield Spread
For those Investors that want to trade often, and especially those that like the “thrill of the kill,” then Spread Betting may be their bag.
The key word here is “Betting.”
Any form of betting is speculative. But in the case of Spread Betting, all trades are a calculated risk. You would require a Spread Betting company to handle your trades.
Spread Betting works particularly well in volatile markets. Sharp changes in prices in the shortest possible time are ideal for Spread Betting.
A profit is made when the underlying security (shares, currency or commodity) moves in the desired direction.
For example: you bet on a particular company’s share price to rise in value from its present value (£1.00) and you placed a bet of £10 for every penny change.
If the share rises 20p then you would profit 20 x £10 = £200 but, if the share fell to say 80p then you would lose 20 x £10 = £200.
The profit/loss on the above example would be before expenses, the “spread.”
As no broker fees are applied the cost of betting on the security rising/falling is taken care of with the spread.
A big advantage of Spread Betting is that there is no income tax or capital gains tax payable as all transactions are classed as bets (i.e. gambling).
S&P 500: America's S&P 500 index is the main benchmark for the world's biggest economy. Financials tend to be the biggest group of stocks, accounting for over 17% of the index. Cyclical companies (those with exposure to the economic cycle) make up more than 72% of the index. For a developed economy, that's high and can make the index fairly volatile.
The Stock Exchanges as we know them today have evolved. When trading in shares first started, they were conducted in coffee houses around the city.
It is reckoned that the first true Stock Exchange was established in 1602 in Amsterdam.
But the fundamentals are still the same: a stock exchange is there for people who want to buy and sell shares in companies.
Trades are made through brokers who are members of the Exchange and that system ensures that buyers pay for what they have ordered and sellers get payed for what they have sold.
Not that long ago, trades were made between brokers on a trading floor of the Exchange (in fact, some still are). But most trades are now actioned electronically.
Stock Market Psychology:
Company shares can be issued at low prices (literally pennies) and grow into big caps (£20, or even higher).
But, if a company grows and its share price grows with it, small investors are put off by the high price. For example, if a share price grew to £50 per share (it can happen) it would cost an investor £5,000 just for 100 shares.
Companies with high share prices become harder to buy and sell, which means they have low liquidity.
Companies get around this by splitting the existing shares into smaller denomination.
If, for example, a company’s shares are priced at £50 per share and there are 500,000 shares in existence then it’s market value would be 500,000 x £50 = £25 billion.
If the company did a 10 for 1 split, meaning that the number of shares in issue would now be 500,000 x 10 = 5 billion and they would be priced at £5 each.
The market value would still be £25 billion but shareholders would now hold 10 shares for every one that they held before.
Share Splits can help the company’s shares being more marketable. Many times this actually benefits the share price and the shares continue to grow.
Warren Buffet’s investment vehicle, Berkshire Hathaway, has NEVER split its shares. A single “A” share in Berkshire Hathaway would now cost over $250,000. He will have his reasons for keeping it that way.
Stock Trading Platform:
This is to do with government revenue.
The main source of revenue for most governments is income tax. So it follows that in times of boom a government’s revenue will rise and equally, in times of recession a government’s revenue will fall.
Government’s may want to keep their public spending at the same level during a recession as they have during up-turns.
This would be called a budget deficit and financed by borrowing money from the bond markets.
Budget deficits called by a temporary changes is known as a cyclical deficit.
If a government spends more than it earns then this type of deficit I known as a structural deficit.
The size of the Structural Deficit is a better indicator of how a government is handling the country’s finances.
A Sub-Rime Mortgage is a mortgage given to a borrower with a low credit rating.
They obviously cost more than a traditional mortgage because of the higher risk. Sub-Prime Mortgages played a key role in the 2008 financial crisis.
Credit rating agencies segregated different credit worthiness into groups. The top was what they termed AAA rated.
Such abundance of credit for housing loans became available because no-one thought that house prices would fall. But they did.
It all resulted in massive panic and the less credit worthy borrowers beg to default on their house loans.
Support and Resistance are two common Technical analysis terms.
Very basically they are points on a chart where a price consistently rebounds from a low point (in the case of Support) and a high point (in the case of Resistance).
These recurring points are “tests” of a share’s price.
And the more times a price tests previous highs or lows, the more reliable is that signal likely to occur again in the future.
Furthermore, once a Resistance level is breached, which it most likely will be one day, then that level becomes one of Support for the price in the future. Likewise, once a Support level is breached, it will become one of Resistance for the future.
These signals are very basic but very effective. It’s uncanny how often Support and Resistance is witnessed on charts.
TAIEX: The Taiex is Taiwan's benchmark index. Unlike other emerging markets, where financials and commodities dominate, it is technology stocks that dominate the Taiwanese index.
Tangible Book Value:
Book Value is also known as Equity, Shareholder’s Funds, and Net Asset Value (NAV).
It is very simply, the value of all the company’s assets, minus all of its liabilities (debts).
But there can be a problem valuing a company this way. The NAV may contain a lot of “intanibel” assets, such as goodwill, branding. Subtracting these intangibles from the Book Value reveals a more conservative figure (the Tangible Book Value).
The Tangible Book Value divided by the number of shares will give you the Tangible Book Value per Share.
If you can buy a share for less than this figure (i.e. if the Price to Book Ratio is less than one), you night be buying a bargain.
Tangible Net Asset Value:
Tangible Net Asset Value is an attempt to show the net worth of a company excluding assets that are hard to value i.e. intangibles such as goodwill, branding and liabilities.
Therefore, Tangible Net Asset Value = total assets – (intangible assets + liabilities)
Take an example of a company with total assets of 200m, intangible of 50m and liabilities of 30m. Its net tangible assets would be:
200 - (50 + 30) = 120m
This figure is also known as the Tangible Book Value.
The higher Net Tangible Assets are, the better.
Sir John Templeton:
Total Expense Ratio (TER):
In order to give you an idea of the costs of investing in funds, fund managers publish what is know as their Total Expense Ratio (TER). It is sometimes more commonly known as the Ongoing Charges Figure (OCF).
The number given is an effort to let you know the annual costs of an investment fund as a percentage of its average asset value over a year.
The TER is composed of the running costs, plus other costs such as administration, marketing and regulation. An attempt to compare the costs of different funds.
But, the TER in some cases ignores some costs such as broker commissions for buying and selling, stamp duty on purchases, and the bid-offer spread when buying or selling investments.
Not all fund managers disclose all costs thereby making it difficult for a true comparison.
The Share Centre:
Index funds (aka trackers) aim to track the performance of a particular index, for example the S&P 500.
The tracker may hold all or a substantial number of the stocks in the underlying Index (in this case the S&P 500).
It is the intention of the fund managers to replicate the performance of the index as close as possible.
Any deviation from the fund and the index is known as the “Tracking Error” or “Tracking Difference.”
Tracking Difference and Tracking Error:
Tracking Difference is the difference between the tracker and the index, in percentage terms.
For example: if an index returns 15% and the tracker fund returns 12%, the Tracking Difference is 3%.
The lower the number the better.
Ideally, a tracker fund, such as the Vanguard Index Fund, will perfectly match the index it follows.
The measure of a good tracker is how close it matches the index.
The Tracking Error is defined as the standard deviation of the difference between the tracker’s returns and the returns of the index.
Or put in another way, it is a measure of how volatile the fund’s tracking difference is, i.e. how much it changes from year to year.
The lower the number the better.
Traditionally when looking at the strength of a currency we look at one currency against another.
For example you might want to look at the dollar’s value compared to that of the Euro.
However, if you wanted to get a better understanding of the dollar’s overall strength, or weakness, it’s better to measure against a basket of currencies. The importance of other currencies depends on the amount of trade done between those countries.
A trade weighted index is useful for measuring the overall performance of a currency against its biggest trading partners, weighting them in line with how much business they do with that country and combining them into a single index.
In other words, the more trade a country does with America (in this case) the bigger the effect it will have on the trade-weighted index.
Under-Trading: See also Overtrading.
Undertrading is the opposite of Overtrading and is defined in the same way, i.e.: capital required/capital available
Undertrading means that the company is under capitalized
Undertrading is much less serious than Overtrading. It generally means that the company has more capital than it actually needs.
Undertrading is not considered serious unless the Undertrading Ratio falls below 0,75
Utilities are companies that provide essential services such as: gas, electricity, water to residential and business customers.
The Utilities Sector also include companies that produce services, such as power plants and companies that distribute the services, such as transmission services.
Upstream energy companies, such as those that extract gas, or oil, from the ground are not classed as Utilities.
Profits from Utility companies tend to be stable – no matter what part of the business cycle. It is regarded as a steady, and constant defensive stock.
However, Utility companies still have to invest in infrastructure. This is often funded through high levels of debt, thus exposing Utilities to changes in interest rates.
Utilities are therefore classed as safe investments but boring.
Generally, shares that are trading on low multiples of earnings or those that have a book value below 1,0 will outperform the market in the medium to long term.
But, some individual shares may look cheap based on their valuation ratios but the low price is an indication of the poor prospects of the company, e.g. it may be in a declining industry.
Such companies, i.e. the ones that look cheap are known as value traps.
One way to side-step a value trap is to simply analyse past earnings over a longer time period, say, 10 years+
Also a company’s situation in the business cycle must be observed and appreciated.
Companies at the top of a cycle may look attractive with their profits rising and trading on low P/Es. Beware.
True value stocks are those that have consistently returned good figures.
Cyclically adjusted P/E ratios are also a big help in avoiding Value Traps.
Velocity of Money:
This is defined as the speed at which money changes hands in the economy.
The more transactions that there are in an economy the higher will be the Velocity of Money.
It is calculated by dividing the nominal value of all transactions in an economy (its gross domestic product, GDP) by the total average amount of money in circulation (the money supply).
Raising money on the stockmarket is a very expensive pastime for new companies wishing to raise cash.
Also, investors are unwilling to stump up money for small companies with no track records.
Consequently, smaller companies turn to Venture Capital firms (VCs) in order to raise finance.
Fledgling companies therefore have money injected into them in return for a stake and a sometimes a say in how they are run.
It’s a big risk for the VCs. Not all companies turn out to be Googles or Amazons. VCs invest in lots of smaller hopefuls but mot don’t make it to the main market.
VCs can, and do, return about 15% a year. But as mentioned above, for every success there are a lot that don’t make the grade.
Venture Capital Trust (VCT):
Vertical Integration happens when two companies at different stages of production merge into one big company.
There are two kinds of Vertical Integration: upstream (or backward) integration and downstream (or forward) integration. The former being when a company moves towards the initial source of the product.
The latter being when a company moves closer to the final customer.
A good example of downstream integration is the oil industry. Both BP and Shell started their businesses extracting crude oil from the ground but became downstream vertically integrated companies when they started buying chemical companies, refineries and filling stations.
Also referred to as Wall Street's "fear guage" is a measure of the implied volatility of the S&P 500 (the main US Stock Trading Index).
Officially it is known as the CBOE (Chicago Board Options Exchange) Volatility Index.
A good measure of the risk in a company is to calculate its volatility.
Volatility is a measure of how much annual returns from an investment rebound from their annual average. This is done using a statistic called standard deviation.
So, the more the investment deviates from its average, the more volatile, or risky is that investment.
Shares in companies and gold are historically known to be volatile (although some more than others). Holding cash and bonds would be less volatile.
It all depends on what kind of investor you are, or what kind of investor want to be.
The greater the volatility doesn’t by always mean greater returns. The mood of the market at a particular time will determine that.
Volume Spread Analysis (VSA):
A computer program based on the principles used by Richard Wyckoff, a legendary stock trader of the 1920s and 30s.
Wyckoff's principles have been developed into the VSA software by the late Tom Williams.
It's basic function being to measure market traded volume with the price spread. The system has been proven to work over any time frame and for any market - equities, forex, futures etc.
VSA assumes that the market under study is in one of four phaes:
The software requires the following variables for each time frame in order for it to automatically calculate he required trading signals:
Armed with the above information, the VA software can automatically give signals that show signs of strnegth or signs of weakness.
The software terminology refers to stock passing from weak holders (amateurs) to strong holders (the professionals).
Weighted Average Cost of Capital (WACC):
Working Capital is an important element of a company's short term liquidity. Liquidity is the cash and assets that are available for the day-to-day running of the company.
Working Capital can obtained by calculating the current assets (cash and assets that can be turned to cash within one year, i.e. stocks of raw material and finished goods) and subtracting current liabilities (outstanding invoices, tax and short-term borrowing repayments).
A company is said have a positive working capital is its current assets are greater than its current liabilities.
The yield, or dividend yield of a share is the dividend per share divided by the current share price.
So, a company with a dividend per share of 5p, and a share price of 100p, has a dividend yield of 5%
Yield On Cost:
Companies pay a dividend, say 5p per share. If that company is successful, then it will want to increase its dividend. Say it increases its dividend by 5% every year for 10 years then that original 5p dividend will have risen to 8,1%
Had you bought the shares 10 years ago at 100p (for round figures) then the 'yield on cost' would now be 8,1% (i.e. 8,1/100).
The 'yield on cost' is of importance to income investors.
Yield Spread: Yield Spread is the difference is a difference in yields (or interest rates) offered by different bonds. You can see if one is a more risky investment than the other.
For example, a yield on a relatively safe 10 year government French bond is 0,5% and a similar Italian bond is 9,5% - then the yield spread would be 9,0% or 900 base points. One base point is 0,01%
Such an example above shows that the Italian bond is a lot riskier than the French bond.
Professional investors watch yield spreads, always on the look out for cheap bargains.