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1 May

Basic Terms

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Market Cap

This is the total dollar market value of all of a company’s outstanding shares. Market capitalization is calculated by multiplying a company’s shares outstanding by the current market price of one share. The investment community uses this figure to determining a company’s size, as opposed to sales or total asset figures.

If a company has 35 million shares outstanding, each with a market value of $100, the company’s market capitalization is $3.5 billion (35,000,000 x $100 per share).

Company size is a basic determinant of asset allocation and risk-return parameters for stocks and stock mutual funds.

The stocks of large, medium and small companies are referred to as large-cap, mid-cap, and small-cap, respectively. Investment professionals differ on their exact definitions, but the current approximate categories of market capitalization are:

Large Cap: $10 billion plus and include the companies with the largest market capitalization.
Mid Cap: $2 billion to $10 billion
Small Cap: Less than $2 billion

I like stocks with a $100 million dollar market cap because the apply to retail and institutional investors.

Revenue

The amount of money a company actually receives during a specific period. It is the “top line” or “gross income” figure from which costs are subtracted to determine net income. Revenue is calculated by multiplying the price at which goods or services are sold by the number of units or amount sold.

Net Income

This is a company’s total earnings or profit. Net income is calculated by taking revenues and adjusting for the cost of doing business, depreciation, interest, taxes and other expenses. This number is found on a company’s income statement and is an important measure of how profitable the company is over a period of time. The measure is also used to calculate earnings per share.  Often referred to as “the bottom line” since net income is listed at the bottom of the income statement. When basing an investment decision on net income numbers, it is important to review the quality of the numbers that were used to arrive at this value. Net income, like other accounting measures, is susceptible to manipulation through such things as aggressive revenue recognition or by hiding expenses.

Earnings

This is the amount of profit that a company produces during a specific period, which is usually defined as a quarter (three calendar months) or a year. Earnings typically refer to after-tax net income. Ultimately, a business’s earnings are the main determinant of its share price, because earnings and the circumstances relating to them can indicate whether the business will be profitable and successful in the long run. Earnings are perhaps the single most studied number in a company’s financial statements because they show a company’s profitability. A business’s quarterly and annual earnings are typically compared to analyst estimates and guidance provided by the business itself. In most situations, when earnings do not meet either of those estimates, a business’s stock price will tend to drop. On the other hand, when actual earnings beat estimates by a significant amount, the share price will likely surge.

Profit

A financial benefit that is realized when the amount of revenue gained from a business activity exceeds the expenses, costs and taxes needed to sustain the activity. Any profit that is gained goes to the business’s owners, who may or may not decide to spend it on the business.

= Total Revenue – Total Expenses.

Profit is the money a business makes after accounting for all the expenses. Regardless of whether the business is a couple of kids running a lemonade stand or a publicly traded multinational company, consistently earning profit is every company’s goal. The path toward profitability can be long. For example, online bookseller Amazon.com was founded in 1994 and did not produce its first annual profit until 2003. Many startups and new businesses fail when the owners run out of capital to sustain the business.

Earnings per Share

The portion of a company’s profit allocated to each outstanding share of common stock. Earnings per share is an indicator of a company’s profitability.

= Net Income – Dividends on Preferred Stock / Average Outstanding Share

Earnings per share are generally considered to be the single most important variable in determining a share’s price. It is also a major component used to calculate the price-to-earnings valuation ratio.

For example, assume that a company has a net income of $25 million. If the company pays out $1 million in preferred dividends and has 10 million shares for half of the year and 15 million shares for the other half, the EPS would be $1.92 (24/12.5). First, the $1 million is deducted from the net income to get $24 million, and then a weighted average is taken to find the number of shares outstanding (0.5 x 10M+ 0.5 x 15M = 12.5M).

An important aspect of EPS that’s often ignored is the capital that is required to generate the earnings (net income) in the calculation. Two companies could generate the same EPS number, but one could do so with less equity (investment) – that company would be more efficient at using its capital to generate income and, all other things being equal, would be a “better” company. Investors also need to be aware of earnings manipulation that will affect the quality of the earnings number. It is important not to rely on any one financial measure, but to use it in conjunction with statement analysis and other measures.

Top Line

A reference to the gross sales or revenues of a company, or an reference to a course of action that increases or reduces revenues. The “top” reference relates to the fact that on a company’s income statement, the first line at the top of the page is generally reserved for gross sales or revenue. A company that increases its revenues is said to be “growing its top line”, or “generating top-line growth”.

This contrasts with net income (or net earnings per share), which is usually the bottom line of the company’s income statement.

While there are number of different business models that have proved to be successful, every company is faced with the two simple goals of:

1. Growing revenues, or generating top-line growth
2. Growing net income, or generating bottom-line growth.

Part of the reason why the term is used so often is that it clarifies minor nuances between the sources of revenue, whether it’s from selling a product, collecting interest or servicing an account. “Top-line” is broad enough to include all of the company revenues into one category prior to calculating other income statement metrics such as operating profit and net income.

Bottom Line

This refers to a company’s net earnings, net income or earnings per share (EPS). Bottom line also refers to any actions that may increase/decrease net earnings or a company’s overall profit. A company that is growing its net earnings or reducing its costs is said to be “improving its bottom line”.

The reference to “bottom” describes the relative location of the net income figure on a company’s income statement; it will almost always be the last line at the bottom of the page. This reflects the fact that all expenses have already been taken out of revenues, and there is nothing left to subtract. This stands in contrast to revenues, which are considered the “top line” figures.

Most companies aim to improve their bottom lines through two simultaneous methods: growing revenues (i.e., generate top-line growth) and increasing efficiency (or cutting costs).

Source: Investopedia

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1 Comment

  1. Dave Troutman

    This was a good refresher for me. However, I need a lesson on the not quite so formal terms that are being used. I have figured out some, but am lost on some others. For example:
    a squeeze, squeeze shorts, swing trade, etc. I hate to sound so much like a rooky, but I have a feeling I really need to know what some of these things mean. I haven’t compiled a complete list as yet, but I can work on one if it would help.

    Reply

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