Other Important Facts about Stocks

Other Important Facts about Stocks

Before investing, it's helpful to learn the key facts, terms, and other important information. Discover what you should know about stocks - before investing - with this stock trading guide from Firstrade.

Key Ratios

Certain key ratios for stocks can be useful tools in analyzing and comparing companies. Financial ratios provide ways to quantify a company's operating success and financial well-being. Valuation ratios help investors gauge how fairly a stock is priced. The financial ratios for a given company don't mean much by themselves, but they are very revealing when compared with the company's historical ratios and with the ratios of comparable companies in the same industry.

  • Return on Assets (ROA): An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's annual earnings by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment".
  • Return on Equity (ROE): A measure of a corporation's profitability that reveals how much profit a company generates with the money shareholders have invested. It is calculated by dividing a company's net income by its shareholder's equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
  • Price/Earnings (P/E) Ratio: Calculated as price per share divided by earnings per share. This is probably the most widely used valuation ratio. It compares a company's stock price to a recent or future level of earnings per share. When looking at a stock's P/E multiple, investors should compare it with the range of P/Es that same stock has been valued at in the past and with P/Es of other stocks of similar companies. P/E should be evaluated in light of various factors, including the rate of changes in expected future earnings.
  • Current Ratio: The relationship between current assets (those that are relatively liquid and/or are likely to be turned into cash within the next year) and current liabilities (payments due within one year). This ratio is especially critical for companies having financial difficulties. For many industrial companies, a ratio in which current assets are at least 1.5 times current liabilities suggests the ability to meet short-term obligations. A ratio of significantly less than that amount could signal a coming cash crunch. However, advisable benchmarks may differ significantly among various industries.
  • Long-Term Debt to Total Capital: Obtained from the balance sheet, this ratio is used to estimate a company's financial strength. It's calculated by dividing long-term debt by total capital. (Total capital equals shareholders' equity plus long-term debt; often this analysis is done as a debt-to-equity ratio.) A "clean" balance sheet has little or no debt. Companies capitalized with 50% debt (a debt to equity ratio of 1:1) or more might be over leveraged; heavy interest payments could limit growth of future earnings and restrict available financing for maintenance or expansion. This concept is similar to looking at the size of a homeowner's mortgage relative to the value of the house. For firms such as utility companies, however, a large proportion of debt, or financial leverage, is typically less of a concern than for other types of companies because utility companies have a relatively predictable and adequate stream of income and cash flow to cover interest expenses.
  • Price-to-Booked Ratio: Calculated as price per share divided by book value per share. This valuation ratio reveals the value set by the stock market on a company's assets. As with other ratios, the price-to-book ratio can be misleading without further information. For example, if a company's assets are carried on its books at far below their actual current value while another company's assets are overstated, a comparison of the two companies' price-to-book ratios will be distorted.

Common Stock & Preferred Stock

There are two main types of stock investments: common and preferred. Common stock usually entitles the owner the right to vote at shareholder meetings and to receive dividends that the company has declared. Preferred stock generally does not have voting rights, but has a higher claim on assets and earnings than the common shares. For example, owners of preferred stock receive dividends before common shareholders and have priority in the event a company goes bankrupt and is liquidated.

Preferred stock is largely owned by institutions and corporations because provisions in the tax laws allow dividends that they receive from preferred stock to be largely tax exempt. In contrast, dividends on preferred stock received by individual investors are fully taxable. Since most of the demand for preferred shares comes from tax-advantaged buyers, who receive a higher after-tax yield, such stock is typically less attractive than other forms of investments for individuals.

Dividends & Dividend Yield

As mentioned in the previous section, a dividend is the portion of a corporation's earnings that is paid to stockholders. Please note that if the stock was purchased on or after the ex-dividend date (the first day the stock trades without the dividend), then you will not be entitled to receive this dividend payment.

To compute a stock's dividend yield, divide the amount of the annual dividend by the current price per share. For example, if a stock is priced at $10 a share and the annual dividend is $0.50 a share, the dividend yield is $0.50/$10.00, or 5%.

Proxy Statement

A proxy statement is a document containing the information that a company is required by the SEC to provide to shareholders so they can make informed decisions about matters that will be brought up at an annual shareholder meeting. Since it is difficult for shareholders of all geographical regions to attend the meeting in person, the proxy statement gives a shareholder the right, not the obligation, to participate in a vote to elect directors or approve certain corporate decisions. After carefully reading the statement to gain an understanding of the issues, shareholders can vote via the Internet, telephone or by mail.

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