LEVEL 3 GLOSSARY
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Dividend
Not all companies pay dividends, but when they do, you should say "Cha-ching!" Dividends are payments the company makes to their shareholders. They're a way of giving the shareholder a piece of the profit pie.
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Dividend Yield
Put your dividend dinero into a percentage: a $1 annual dividend for a $10 stock has a 10% yield.
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Earnings Per Share
This is the amount of money earned per every one share. If the company made $1 million in profits and has 1 million shares outstanding, the EPS would be $1.
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Liability
Think of this as debt, but then cast the net a little wider. Liability is the obligation to repay its loans, IOUs, payroll, leases, pensions, vacation hours, and taxes a company owes.
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P/E Ratio
Stocks work hard for the money, so hard for it honey—ahem. P/E ratio is "price-to-earnings": it tells you how much you’re paying for the earnings that a share is generating. For those of you who are visual learners, P/E Ratio = price per share / earnings.
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Retained Earnings
If you're expecting a dividend check and end up empty-handed, it could be because the company decided to keep the earnings and put them back into the business. This money, and all other earnings the company keeps, are called retained earnings. The amount of a company's retained earnings can be found in the shareholders' equity section of the balance sheet.
See full glossary
In Level 3, we'll introduce you to the advanced concepts of investing. Just like the first two levels, there will be some concepts and one quiz. Ace the Level 3 quiz and people will be very impressed when they see your Report Card. So dig in, have fun, and ace that quiz! Good luck!
- The role of risk
- Diversification
- Corporate actions
- Dividends
- Reinvesting
- Issuing more shares
- P/E ratio
- LEVEL 3 QUIZ
P/E ratio
What we'll learn:
1. What does P/E stand for?
2. How is the P/E ratio calculated?
3. Why does it matter, anyway?
If you hang around with financial types (and you have our sympathy if you do), you might hear them throw around "P/E" numbers: "15 P/E," "10 P/E," "the market has a 7 P/E."
Ok, it makes them sound kind of smart, but what does P/E mean? Well, it's not physical education and it's not pickled eel. (No, thanks.)
P/E stands for "price-to-earnings ratio," and it's typically a measure of a company's share price divided by its earnings from the last 12 months.
We'll slow down for a second and do the math. Let's say a company has a million shares outstanding, and that same company earned $1 million over the last year.
That means their earnings-per-share figure (simply: earnings divided by shares outstanding) is $1. And if the price of one share of stock is $10, then the P/E — share price divided by earnings — is 10.
OK, but why are your nerdy financial friends talking about this, you ask? Why do people even bring it up?
The whole point of P/E is to quickly describe what happened to a company during the past year, and how it's doing financially.
The concept of P/E also has to do with expectations — higher P/E ratios suggest people are likely expecting higher earnings from that company in the future.
And, of course, the opposite is the case for lower P/Es.
Some people also think of the P/E ratio as a way to quantify what investors are willing to pay for shares of a company's stock. Why?
Because if a stock with a high P/E ratio is "more expensive," it means people are expecting bigger things for it and are willing to pay a little more for that extra performance.
Think about it like a sports car — people pay more for them for many reasons. But some people buy them because they're faster. The faster they go, the more some customers are willing to pay.
Same with P/E ratios. The difference is that P/E is based on what happened in the past, not necessarily on what is going to happen in the future.
So buying a stock based only on its P/E ratio is like paying more for a car just because someone tells you it might be faster than the competition.
Three Facts to Wow Your Friends at a Party
1) Historically, the average P/E ratio of the market has been 15–25.
2) Start-ups typically have higher P/E ratios than blue-chip companies.
2) Some investors believe P/E ratios are a way of knowing if a company is cheap or not.
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