LEVEL 2 GLOSSARY
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Balance Sheet
This financial statement tells you if the company is in the black (good) or red (bad). The statement details the good, the bad, and the ugly of the company's liabilities, assets and shareholders’ equity. One rule to remember here is a company's assets = liabilities + shareholders' equity.
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Book value
Theoretically, it’s what a shareholder would receive if the company were liquidated or sold for cash today. As we all know, the books don't always reflect the reality.
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Income Statement
One of the three common financial statements that is basically the company's quarterly budget. This is how much the company made and how much it spent, the bottom line (literally) being the profits left over.
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Market maker
A brokerage firm that is willing to sell you a stock (at the bid price) or buy one back from you (the ask price). They play both sides and make money off of each. Brilliant!
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Security
Basically, any contract representing ownership, such as stocks, bonds, options, swaps, notes, and futures. It says, "I OWN THIS"
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Shares Outstanding
The total number of shares currently held by investors.
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Statement of Cash Flows
Do you balance your check book? So do companies, and this is what it looks like. This is one of the three common financial statements compiled by a company. It shows how the company generated cash and where it spent it.
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Value Investing
An investment strategy that relies on picking stocks that are undervalued by the market and hoping that the market catches up at some point.
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Annual report
This report airs the company's dirty laundry with the freshest spin possible. They tell you what happened last year and what the financials look like all in one place, they can usually be found filed with the SEC or on the company website. Companies are required by law to put these out, but don't get fooled by the pretty pictures—the bad stuff is in there too.
See full glossary
In Level 2, we'll take you a little deeper into the trading world. Like in Level 1, there are a series of concepts that you should master before taking the Level 2 quiz. Remember to click the "Mastered this concept?" link at the bottom of the page to keep track of your progress in your Report Card.
- Invest in what you know
- Working at the stock market
- Price of stock
- What affects share price?
- Judging a stock
- The Fair-Price Rating
- Shares outstanding
- Where to learn about a company
- Growth investing
- Value investing
- Invest like Buffett
- The government's role
- LEVEL 2 QUIZ
Value investing
What we'll learn:
1) What the heck is a value stock?
2) How to avoid the value trap
3) What makes a stock cheap?
To become a smart investor, you have to ask yourself several questions. And one of those is: What kind of investor do you want to be?
If you want to make money and you've got plenty of time, you look for a bigger company, like an Exxon (XOM) or an AT&T (T). Its gains will likely be pretty slow and steady. You probably won't become a gazillionaire, but you won't lose your shirt, either.
But if you want to make a big splash, well, that's when you go for a value stock.
Wait — what's a value stock?
A value stock is typically defined as a stock that's valued at a lower price than what it is worth. These stocks are considered to be "cheap," because the price is low relative to earnings.
So this is a way to make some good coin — if the stock turns around, that is. Since the market doesn't expect the company to outperform, positive surprises are likely to lead to some sweet gains in performance.
But here's the thing: You might see that low price and think, "Hey, this stock is in the toilet — I'll get it, and when it bounces back, I'll be rich!" Don't be fooled.
You're heading for what's called the "value trap," which is when an investor purchases a stock because it looks cheap but fails to see the market rationale for the low price. In this scenario, the investor is in danger of the stock dropping so much that the company disappears altogether.
Yikes!
But if you're smart, there are some good buys to be found here: Value stocks can be thought of as troubled stocks that are solid, but the market has overreacted and pushed down the price.
So you might feel positively about the company, but the market does not.
So before you invest, it's important to determine if the market is just being too negative about a company, or if there is truly something wrong with its fundamentals.
So wait — how can the market overreact? Here's one way: If the company missed its earnings projection by a penny and the stock decreased by 25 percent, the market might have gone a little overboard.
This could lead to a potential gain if you bought the stock and held it until the market realizes its mistake.
Sometimes the market will underreact to news as well. For example, let's say a company missed its estimated earnings by 25 cents, but the stock only decreased by five percent. The percentage decline probably should have been a bit larger.
There are other newsworthy actions that could create an under- or overreaction. For example, a merger could be announced and the market might not react as quickly or as positively as you feel it should, creating a value stock.
The bottom line is, to make sure you're getting a smart value investment and not just a messed-up company, you need to apply some of Warren Buffett's wisdom here.
Smart value investing requires both the understanding of why the company is being undervalued by the market — that is, why the negative sentiment — but also, the financial health of the company.
If you have some solid knowledge here, you can avoid the treacherous value trap. Again, the objective is to find good, solid companies that have unfairly taken a beating on Wall Street. And what's unfair for them could be very fair for you.
Three Facts to Wow Your Friends at a Party
1) Charlie Munger, Warren Buffet’s right-hand-man, once said, "All intelligent investing is value investing."
2) At its peak, Google (GOOG) was trading for more than 100 times its earnings, yet was considered a “value stock.”
3) Cheap stocks with mediocre (or worse) businesses are casually referred to as “trash stocks.”
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