A More Advanced Guide to Understanding Terms Used in the Stock Market

In an earlier article, I tried to break down some of the more commonly used terms in the stock exchange that someone who is starting out should know.

In this article, I’ll try and break down some of the more advanced terms that are used in the stock market.

Yield

A yield is the measure of return on investments in terms of percentage. Stock yield is calculated by dividing the current price of the share by the annual dividend paid by the company for that share.

For example, if the current price of the share is KSh 100 and the dividend paid is KSH 5 per share annually, then the stock yield is 5%.

Income Stock

This is a stock which has a solid record of dividend payments and offers dividend higher than the common stocks.

Overvalued Stock

An overvalued stock is a stock whose current price is considered to be higher than what it should be. This is calculated by metrics such as the Price-to-Earnings ratio.

If a stock is considered to be overvalued, the price of the stock is expected to drop down.

Undervalued Stock

An undervalued stock is a stock whose current price is lower than its actual value. Investors will buy these stocks to get higher returns in the future.

Capital Gains

A capital gain is an increase in value between the price a share is sold for and the price that an investor paid for the asset.

Day Trading

Day trading is the practice of buying and selling shares within a single day. Day traders will frequently buy and sell shares within several hours, or even several minutes to make quick profits.

Traders who take part in day trading are often called “active traders” or “day traders”.

Consumer Price Index (CPI)

The consumer price index examines the average cost of a select group of consumer goods and services that range from food and beverages to smartphones and medical care.

Price-to-Earnings Ratio (P/E)

The price-to-earnings ratio helps you compare the price of a company’s stock to the earnings the company generates. It lets investors see whether the price of a stock accurately reflects the company’s earnings potential or its value over time.

A high P/E ratio means two things – either the company’s stock is overvalued, or investors expect a high growth rate in the future. You can arrive at the PE ratio by dividing the current stock price by earnings per share.

Return on Equity (ROE)

Return on equity measures the overall earning performance of a company and also helps in measuring the profitability of different companies in the same industry.

Higher ROE indicates that the management is doing a fine job in boosting business, adding to the wealth of its shareholders in the process.

Debt-To-Equity Ratio

A company’s debt-to-equity ratio is a performance metric that measures a company’s level of debt in relation to the overall value of its stock.

In simpler terms, it is a measure of how well a company uses debt to finance its operations. Investors use it to gauge the health of a business.

If a company has a high debt-to-equity ratio then that suggests the company may be relying too much on loans to fund operations. This makes it a high-risk investment.

But, if the ratio is too low then that suggests the company is paying for most of its operations with shareholder’s equity. This is an inefficient way to grow a business.

Earnings Per Share (EPS)

This is an investment metric that determines a company’s profit divided by its number of common outstanding shares. The result usually serves as an indicator of a company’s profitability.

The higher a company’s EPS, the more profitable it is considered to be and vice versa.

Retained Earnings

Retained earnings tell you how much profit a company has left over after paying out dividends.

Return on Equity (ROE)

Return on equity is a measurement of how efficient a company is in using its assets from its shareholders to create earnings.

Real Estate Investment Trust (REIT)

A Real Estate Investment Trust is a company that owns, operates, or finances income-producing real estate. It allows investors to invest in real estate without requiring them to directly purchase individual properties.

An example of a REIT in Kenya is ILAM Fahari I-REIT

Final Note

By grasping most of these terms, you will be able to read or follow conversations about different company performances in the stock market. This will greatly aid you in your research of the best stocks to invest in.

If you have read all this and feel comfortable enough to start investing in the Nairobi Securities Exchange, then here is an article I wrote to guide you on how to get started.