Fundamental Stock Market Concepts Every Investor Should Know
Stock Market Concepts
- Return on Investment (ROI)
This measures the performance of any investment. Simply put, if you invest $500 in five different places, you want the investment that gives the highest return. ROI is the most important metric to consider when investing, whether you are a businessman or an investor.
- Price-to-Earnings Ratio (P/E Ratio)
The P/E ratio compares a company’s current share price (market price) to its per-share earnings. A high P/E ratio might indicate that a stock is overvalued, or investors are expecting high growth rates in the future. - EPS (Earnings Per Share)
EPS is a company’s profit divided by the number of outstanding shares. This indicates the company’s profitability by showing how much profit the company makes per share. The higher and more consistent the EPS, the better it is for the company.
- Balance sheet
The balance sheet provides information on a company’s assets, liabilities, and shareholder’s equity. It is crucial for determining the company’s capital structure and rate of return. The balance sheet shows how much a company owns versus how much it owes, providing a clear picture of its financial health.
- Profit and Loss Statements
These statements show a company’s ability or inability to generate profit by increasing revenue. In the Indian context, some companies record sales on paper without actually selling the product, which can be misleading. Therefore, it is better to focus on cash flow statements and balance sheets rather than just profit and loss statements.
- Quarterly reports
These reports, released every three months, provide an update on a company’s performance. By examining these reports, investors can monitor any deviations and make informed decisions about their investments.
7. Leverage
In trading, leverage involves borrowing funds to increase one’s investment capacity. While leverage can amplify profits, it also increases risk. Many successful companies operate with high leverage, making it a crucial investment strategy for ongoing projects.
Let’s talk more about leverage.
When a company is said to be leveraged, it means it has taken on more debt compared to its own equity. This can boost returns but also adds risk. Companies in sectors like banking or real estate often operate with high leverage, making them more vulnerable compared to those in IT or manufacturing.
In simpler terms, think of leverage as using borrowed money to make more money, but with the understanding that there’s a risk of losing more too. Companies use this strategy to grow faster and take on bigger projects, but it requires careful management to avoid financial trouble.
8. Bond market (also known as the debt or credit market)
It allows companies to raise funds in several ways: issuing equity, taking loans (which usually have higher interest rates), or issuing bonds. Bonds promise fixed returns over a set period. However, bondholders bear the risk of the company underperforming or going bankrupt. Bonds are attractive for investors seeking better returns than fixed deposits, offering a steady revenue stream for companies.
- Cash flow statement It helps you understand how much cash a company generates from its operating, investing, and financing activities. Essentially, it shows the actual cash inflows and outflows, providing a clear picture of the company’s liquidity.
- IPOs (Initial Public Offerings) An IPO is when a private company first offers its shares to the public, transitioning to a public company. This process allows companies to raise capital for growth and development. IPOs can be very attractive for investors, but it’s important to conduct thorough analysis before investing.
To summarize, these are the key concepts every investor and businessman should understand to make informed decisions in the stock market. By focusing on ROI, EPS, balance sheets, profit and loss statements, cash flow statements, quarterly reports, and leverage, you can gain a comprehensive understanding of a company’s financial health and potential for growth.
Understanding these concepts will help you make more informed decisions and navigate the stock market more effectively. More About Finance
