The Average Joe's Stock Market Survival Guide - The Average Joe

    The Average Joe’s Stock Market Survival Guide

    Victor Lei — Head of Research

    June 6, 2021

    June 6, 2021

    Read time: 6 minutes

    Traditional financial media is long, complex and dry. We’re here to change that.

    We simplify the concepts as much as we can but there are things we can’t change with the industry — all the abbreviations, terms and jargon they love using.

    To better understand the newsletter content, these are some terms/concepts we commonly use:

    Exchange-traded fund (ETF)

    An ETF is a type of investment that can be bought and sold like a stock. Just like a stock, investors can see their prices go up and down during market hours. 

    Unlike a stock, which represents ownership in a single company, an ETF will commonly hold a basket of stocks or assets. 

    Why does this matter? ETFs have become a popular investment for easy diversification and to get exposure to specific industries or assets. For example, investors can invest in the following ETFs:

    • The SPDR S&P 500 (NYSEARCA:VOO) tracks the return of 500 of the largest companies in the US.
    • The First Trust NASDAQ Cybersecurity (NASDAQ:CIBR) is a sector-themed ETF that invests in ~41 cybersecurity companies.
    • While it’s difficult for retail investors to invest in oil, the United States Oil (NYSEARCA:USO) is an investment that replicates the return of oil prices.

    One way to think about it: ETFs give investors ways to access investments that were difficult or tedious to invest in before.

    In the newsletter: We’ll talk about various industries and will often give an ETF as an example to get exposure to that industry.

    See here for the benefits of investing in an ETF.

     

    The S&P 500 Index

    The S&P 500 is an index that tracks the performance of 500 companies that are among the largest in the US by market capitalization.

    The index consists of companies from all sectors including financial, information technology, and healthcare. Given how diverse the index is, you can think of this as a scoreboard for how the US stock market is doing.

    Why does this matter? The S&P 500 is commonly used as a benchmark to other investment returns. When the stock market makes a big move, you’ll often see financial publications mention “The S&P 500 moved up X%”.

    • In the 10 years up to June 3, 2021, the annualized return of the companies in the S&P 500 is 12.42%.

    Can you invest in the S&P 500? While you can’t invest directly in the S&P 500, there are ETFs that replicate the returns of the S&P 500. See here.

     

    The Nasdaq Composite Index

    Commonly referred to as the “Nasdaq”

    Similar to the S&P 500, the NASDAQ is also a stock market index. The difference is that the Nasdaq tracks the performance of the stocks listed on the Nasdaq stock exchange — which consists of over 3,000 companies.

    Unlike the S&P 500, which is more sector-diverse, technology companies make up a higher portion of the Nasdaq index. 

    Why does this matter? When financial publications talk about the performance of the tech sector, they’ll often refer to the Nasdaq index — i.e. “The Nasdaq moved up X%”.

     

    Initial public offering (IPO)

    The IPO is the process used by a company to go public on the stock market.

    Not all companies are available on the stock market: Investors cannot buy shares in a private company — i.e. Small businesses and startups are often private companies.

    • Investors can only buy a company’s stock on the stock market when the company goes public. The IPO is one of the processes of going public.

    For retail investors, here are the dates related to an IPO to be aware of:

    • IPO filing date: When a company files to go public, they officially announce their intentions to go public — and investors get access to their financial details to learn about the state of the company.
    • The IPO listing date: When a company officially goes public — and their stock is available to buy.

    Why does this matter? IPOs are an exciting way to get access to new companies. In the newsletter, we’ll cover the most exciting and relevant companies going public.

     

    Net income/profit

    Companies earn revenue/sales from selling their products or services. From that, they pay out expenses (i.e. marketing, cost of goods, salaries, etc). What’s left over is the net income, commonly referred to as net profit.

    Why does this matter? When we talk about a company, we’ll often provide their net income/profit, which is one factor used to consider the financial health of a company. However…

    • Just having the net income of one period won’t give us much information. It’s important to compare to previous periods.
    • If we say a company made $X in net income for 2021, we’ll also provide what its net income was the previous year to understand whether its financial health is improving or getting worse.

    Net income/profit margin

    This is the net income/profit as a percentage of their sales.

    For example: If a company made $1m in sales and their net profit was $250,000, they have a net income margin of 25% (1,000,000 divided by 250,000)

    Why does this matter? This is an important measure of a company’s health. The higher your net margin, the more profitable the company is.

      • The margin is also commonly used to compare the profitability/state of different companies.

    Price-to-earnings (P/E) ratio

    In mathematical terms: The ratio is used in investment analysis to compare one company to another — calculated by dividing a company’s earnings per share by its stock price. 

    • i.e. If a company’s stock price is $10 and its earnings per share is $2, the P/E ratio is 5x (10/2 = 5).

    Why does this matter? The ratio is used to compare whether a company is undervalued or overvalued (cheaper or more expensive) compared to other companies.

    • If the P/E ratio is 10x, it means you’re paying $10 for every dollar the company makes in net income. 
    • If another company has a P/E ratio of 20x, you’re paying more to buy a single dollar of its net income. The higher the ratio, the more expensive the company is considered. 
    • But, companies growing faster tend to have a higher P/E ratio, to accommodate for expected growth. 

    Why do we have to use ratios? We can’t gauge whether a company is undervalued/overvalued just by comparing their sales or earnings alone.

    • When company A makes $10m a year and company B makes $1m a year. We can’t tell whether one company is cheaper. 

    How does it work? Say company A has a P/E ratio of 10x and company B is 5x. We consider the one trading at 10x to be more expensive. But the P/E ratio can’t be used alone to tell whether a company is undervalued/overvalued. The tool must be used alongside other valuation tools. 

    In most investing platforms, the P/E ratio is calculated for you.

     

    Other things you need to know

    Abbreviations: $1m means $1 million, $1b means $1 billion

    How we write tickers: Whenever we mention a publicly traded company in the newsletter, we’ll give the ticker in this format (NASDAQ:AMZN).

    • The first section “NASDAQ” refers to the stock exchange that the stock can be found on.
    • The second section “AMZN” refers to the unique ticker (identifier) of the company. When you search for a stock in your app, you’ll often search for the company name or the ticker.

    Now that you’re acquainted with the terminology, check out our past issue here to get started.

    More resources:

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