Key Terms To Stock Market

Market Capitalization

A company's market capitalization (or "market cap") is calculated by taking the number of outstanding shares of stock multiplied by the current price-per-share. It is the amount of money you would have to pay if you bought every share of stock in a company.

The price that an investor pays for a security. This price is important, as it is the main component in calculating the returns achieved by the investor.

For example, if an investor buys XYZ at $35, then this would be the purchase price. When looking at the return on the investment, the investor would compare the purchase price of $35 to the price the investment was sold at or the current market price for XYZ.

Share

Certificates representing ownership in a corporation. Shares are also known as stocks or equities.

P/E Ratio

The P/E ratio is how much money you are paying for $1 of the company's earnings. If a company were currently trading at a P/E of 20, an investor would be paying $20 for $1 of earnings.

The P/E looks at the relationship between the stock price and the company's earnings. You calculate the P/E by taking the share price and dividing it by the company's EPS.

In other words, if a company is reporting a profit of $2 per share, and the stock is selling for $20 per share, the P/E ratio is 10 because you are paying ten-times earnings
[$20 per share dividend by $2 per share earnings = 10]

In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E.

However, the P/E ratio doesn't tell us the whole story itself. It's usually more useful to compare the P/E ratios of one company to other companies in the same industry, or to the market in general, or against the company's own historical P/E.

It would not be useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a technology company (high P/E) to a utility company (low P/E) as each industry has much different growth prospects.

Price / Earnings To Growth - PEG Ratio

A ratio used to determine a stock's value while taking into account earnings growth. The calculation is as follows:

PEG Ratio = Price to Earnings ratio / Annual EPS Growth
PEG is a widely used indicator of a stock's potential value. It is favored by many over the price/earnings ratio because it also accounts for growth. Similar to the P/E ratio, a lower PEG means that the stock is more undervalued.

Keep in mind that the numbers used are projected and, therefore, can be less accurate. Also, there are many variations using earnings from different time periods (i.e. 1 year vs. 5 year). Be sure to know the exact definition your source is using.

Short Selling

The selling of a security that the seller does not own, or any sale that is completed by the delivery of a security borrowed by the seller. Short sellers assume that they will be able to buy the stock at a lower amount than the price at which they sold short.