In this article, I want to talk about valuing stocks, and basic stock market terms to help you understand investing, in plain language.

There are numerous ways to value stocks, but this article will keep it as basic as possible.

I’m not a stock market buff, or guru of the markets, but I know enough to help others understand some of the basics.

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Here are 12 definitions and simple explanations to help you understand how to value stocks.

1. Stocks

Simply put, stocks are shares of a company. When you buy shares of a stock, you essentially become a partial owner of the company’s profits.

You can buy single stocks or groups of stocks such as mutual funds, index funds, and exchange traded funds (ETFs).

2. Price (Cost) of a Stock

The price of a stock is simply the price of an individual stock, or one share of a stock. You can find the price of stocks in various places on the internet.

Websites like yahoo finance or morningstar.com are great places to research current stock prices.

3. Value of a Stock

The value of a stock is what the stock is actually worth. This can be a little more difficult to determine, and can take on many variables. There is a difference between a stock’s price and it’s value.

Valuing a stock is similar to valuing a home.

When you are looking to buy a house that is priced greater than all of the comparable homes around it, then the house you are wanting to buy is overpriced, based on the value of the houses around it.

And this is the same on the flip side. If the house is priced less than other homes, than it’s underpriced.

The same concept applies to purchasing a stock.

When investing, you want to determine whether or not a stock is overpriced, underpriced, or fairly priced, before buying it.

In order to do this, you have to learn how to assign value to a stock. Is the stock undervalued, overvalued, or valued just right?

Keep reading. The definitions below will help you determine how you can value a stock.

4. Earnings

Earnings are a company’s profits in the past 12 months. A company’s earnings are a measure of how profitable a company was in the past year and is an indication of the financial strength of a company.

5. Earnings Per Share

Earnings per share (EPS) are a company’s earnings (profits or net income) in the past 12 months divided by the company’s total outstanding shares of stock.

The higher a company’s earnings per share (EPS), then the more likely the company is strong enough to pay dividends and stay afloat.

6. Price Earnings Ratio (P/E Ratio)

This is one of the most common ways people assess an individual stock. When it comes to valuing stocks and basic stock market terms to help you understand investing in plain language, the P/E ratio is crucial.

The P/E ratio is a measure how much an investor makes per each dollar invested in a particular stock. The “P” is the price and the “E” is the EPS.

So the P/E ratio is the current price of a stock per share divided by the EPS.

Here is an example:

If the current price of a stock is $100 per share and the EPS is $5, you are paying $100 per share of the stock for a claim on earnings per share of $5.

The $100 divided by $5 = 20. So the P/E Ratio is 20.

Here are a few rules of thumb:

Undervalued stocks typically have a P/E ratio under 10.

Fairly priced stocks typically have a P/E ratio around 15.

Overpriced stocks have a P/E ratio of around 20.

Stocks with a P/E ratio above 30 are considered a bubble and very risky.

You typically never have to do these calculations yourself. Simply go to Google and type in any company’s PE ratio and it will tell you exactly what their current EPS is, and their current P/E ratio.

Believe it or not, It’s that simple!

Now you can value stocks. However, remember there are other variables that come in to play when you value a stock.

Don’t use the EPS and P/E ratio as the sole determining factor to purchase, or not to purchase, a stock. There are other important indicators.

Some other important terms to know

7. Dividend

Dividends are a company’s distribution of some of its earnings back to its shareholders.

They are simply a portion of profits a company’s Board of Directors decides to pay its investors, and can be paid in cash, stocks, or any asset.

Most company’s do quarterly dividends per share.

Click HERE to read more about dividends.

Click here to check out where to invest your money in 2021

8. Yield (Earnings Yield)

The yield is another way of valuing a stock and it’s typically considered a measure of risk.

The yield is the last twelve months of EPS divided by the current price of a stock.

It is a measure of the return you get from an investment in a stock, based on the dividend you receive.

Here is an example:

A company has an EPS for the last twelve months of $5 per share, and the company is currently priced at $100 per share. The yield would simply be $.05 or 5%

9. Market Capitalization

Market capitalization (Market Cap) is the Price of a company’s individual stock times the total number of outstanding shares.

In other words, the market capitalization is the total dollar value of a company’s outstanding shares of their stock.

Outstanding shares are the shares of stocks that have been authorized, issued, and purchased.

10. Index

This is a subset of the stock market. An index can contain a specific group of companies that are listed on indexes such as the Dow Jones, the NASDAQ, or the S&P 500.

An index can also be described as a subset, or group, of stocks, which either represents the market as a whole (such as the S&P 500) or a specific sector of the market, like technology, retail companies, or healthcare.

The S&P 500 is about 70% of the entire market capitalization, so it’s an index that is a good indicator of the entire market. This is why it’s so popular.

11. Capital Gains

Capital gains represents the increase in the value of an asset. A capital loss is a decrease in the value of an asset.

12. Initial Public Offering (IPO)

When a private company offers their shares to the public for the first time. Click HERE to check out the top 10 IPO’s of all time.

The bottom line:

These are the basics and represent a very simple, yet informative, way to look at stocks.

When it comes to valuing stocks and basic stock market terms to help you understand investing in plain language, I hope this article is helpful.

Remember, this is just an introduction and it gets much more complicated. You have to master and understand the basics first.

Happy Investing!

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ABOUT THE AUTHOR

Eric is the founder of Smart Money Bro, a blog about empowering people and discussing practical ways ordinary people can be extraordinary with their money. He only writes about things that he has done, and that actually work.

He’s made mistakes and has turned his financial future around, and is now in the position to help others do what he’s done. Read More