What is an Index?
An Index is a customized portfolio that represents the market value of a particular sector or portions of it.
The portfolio could be composed of several publicly traded companies, or as little as 20 companies. It is usually expressed in terms of change from a base value. Each index has its own calculations methodology.
To give an example, the Amman Stock Exchange is the index that tracks the performance of the listed companies in the Jordanian market. The Dow Jones Index is another example of a well-known index, which also tracks the performance of large-cap stocks in the United States. Another example is the Standard and Poor’s 500 Index (S&P 500) is one of the most popular indices that track the performance of large and midcap US stocks.
What Do Earnings Mean?
It is the income that a company generates from its operations and other sources of income (investment, sales of assets, etc.) during a given period of time, usually a quarter (three months) or a year. Earnings characteristically refer to the profit a company earns after operating expense, taxes, and interest charges are deducted. Ultimately, a business's earnings are an important factor in determining a company’s profitability and in turn in determining its stock price.
What Does Earnings Per Share – EPS Mean?
The EPS represents the earnings returned on an initial investment amount. It is generally considered to be the single most important variable in determining a share's price.
Calculated as: EPS = Net Income / Outstanding Shares
Assume that company X has a net income of JD8 million and outstanding shares of 16 million, while company Y has a net income of JD8 million and outstanding shares of 20 million. The EPS for company X would be JD0.5, which is calculated by dividing 8 million by 16 million, while the EPS for company Y would be JD0.4. If both companies are from the same industry, then comparing the EPS would be beneficial in determining which stock to purchase.
In this instance, it would be better to purchase stocks from company X. However, it is worthy to note that one should not base their decision on the EPS alone, and should consider other determinants.
What Does Price-Earnings Ratio – P/E Mean?
The Price to Earnings Ratio of a stock, referred to as a “multiple”, is a financial ratio used for valuation. It is a measure of the price paid for a share in relation to the annual profit earned by a company. It indicates what an investor is willing to pay to own a share in a certain company. In other words, the PE ratio indicates how much an investor is willing to pay for one Jordanian Dinars of earnings. It is generally assumed to be a better indicator of what the stock’s real value is. It is worthy to note, that when comparing companies it is only useful to compare the PE’s of companies that are in the same industry as different industries have different growth rates.
It is important to remember that while the PE ratio takes into account the company’s historical performance, it also factors in the market’s expectations of a company’s future growth. This is because future growth is already incorporated in the stock price. Therefore if a company has a high PE, specifically higher than the average P/E of the industry, then one may assume that this particular stock is over-priced. On the other hand, if a company has a low P/E, specifically lower than the average P/E of the industry, then one may assume that this stock is undervalued and that there is a good potential in the market for this stock to appreciate.
If company X is trading at JD16.20, while its earnings per share amounted to JD1.24, then the P/E ratio for the stock would be calculated by dividing 16.20/1.24 which equals 13.06.
What Does Book Value Mean?
Book value is the difference between the original cost of an asset and its accumulated depreciation. In other words, the book value of the company would be the difference between its total assets and total liabilities. When compared to the firm's market value, the book value can indicate whether a certain stock is under- or overvalued.
What does Price-To-Book Ratio – P/B Ratio Mean?
A financial ratio used to compare a company’s current market value to its book value.
It is also known as the "price-equity ratio". This ratio determines whether a stock is overvalued or undervalued. If the PB ratio is less than 1, it generally tells investors that the price is understated or that the company is earning negative returns on its assets. Comparing price to book ratios between various stocks in a sector may give preference to certain shares.
Calculated as: P/B = Share Price / Book Value per Share
Suppose company X has JD100 million in assets, and JD80 million in liabilities. The book value of company X is then JD20 million. Assume also company X’s outstanding shares are JD10 million, then the P/B ratio is 2.0 of book value. The company’s stock price is JD 5, therefore if you divide 5 over 2, the price to book ratio would amount to 2.5.
What Does Return on Asset Ratio - ROA, Mean?
An indicator of how profitable a company is in regards to its total assets. ROA gives an idea as to how successful management has been in employing resources that generate earnings. Sometimes this is referred to as "return on investment".
If a company A has a net income of JD2 million and total assets of JD10 million, its ROA is 20%. Let’s assume company B earns the same amount but has total assets of JD20 million, it has an ROA of 10%.
Based on this example, company A is better at converting its investment into profit than company B.
What Does Return on Equity Ratio - ROE, Mean?
Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.
Calculated as: Return on Equity = Net Income/Shareholder's Equity
Assume that two companies have the same net income at JD20 million but different shareholder’s equity: Company A has JD50 million in shareholder's equity, and Company B has JD100 million in shareholder's equity. Company A reveals an ROE of 40% (JD20m/JD50m) while Company B, shows an ROE of 20% (JD20/JD100). Company A shows the highest return on equity.
What Does EBITDA Mean?
It is the earnings before interest, tax, depreciation and amortization. It is an approximate measure of a company’s operating cash flow based on its income statement. EBITDA is generally used to compare profitability between companies and/or industries.
What Does Dividend Mean?
A dividend is a portion of the company’s profits paid out to stockholders. When a company makes a profit, it can do one of two things; it can use the surplus cash to reinvest in the company, which is referred to as Retained Earnings, or it can pay a portion of the earnings to stockholders as dividends. Dividends may be in the form of cash and/or stock. Usually, profitable and liquid companies pay dividends.
What Does Dividend Yield Mean?
A financial ratio that shows how much a company pays out in dividends each year relative to its share price. In the absence of any capital gains, the dividend yield is the return on investment for a stock..
If two firms both pay annual dividends of JD1 per share, but firm A’s stock is trading at JD20 while firm B's stock is trading at JD40, then firm A has a dividend yield of 5% while firm B is only yielding 2.5%. In a case like this, investors would choose firm A over firm B seeing that firm A would be the more profitable choice.
What is Margin Lending?
Margin lending allows the investor to borrow money from the brokerage firm for the purpose of buying stock. A client usually uses a margin loan when they do not have enough money to buy the intended stocks. The amount of credit owned is based on the client’s portfolio which is put up as collateral for the loan. Margin lending typically has a margin rate, which is the interest charged on the loan.
What does Margin Call Mean?
It is a call by a broker to the investor demanding the deposit of cash or liquidation of securities in order to bring his margin up to the minimum requirement. This is typically done to cover losses that have been accumulated due to losses incurred on margin lending.