Investing Terminology

On this page, I’ll define and elaborate on some of the terms we use in our articles or posts. While this is certainly not a complete list, there are plenty of other resources out there that can be helpful to check out or buy. One of the best “investing dictionaries” that I use is the Dictionary of Finance and Investment Terms by Barron’s. It is quite hefty at around 900 pages, but a great tool to buy for about $10. Any time you see a term that you don’t recognize, it is likely in this book somewhere.

Basic Definitions:

Capital Structure: The mix of both debt and equity on a company’s balance sheet. To figure this out, you can search through a company’s financial statements in it’s 10-k, and then take the ratio of the total debt divided by the total equity. Some investors like to modify this slightly, but it’ll do for us right now.

Efficient market theory: the EMT holds that stockpicking is essentially futile because all available information is already priced into the stock. There are different forms of the theory, all of which have varying degrees of absurdity. The strong form version, for instance, argues that all public as well as private (insider) information is always reflected in the stock market.

Financial Statements and SEC Filings:

These are the bread and butter of any part time investor’s toolkit.

Balance Sheet: The balance sheet is where you want to look if you want to see what assets or liabilities a company holds. Assets include obvious things like cash on hand or equipment or real estate, but also intangible things like trademarks and goodwill. Liabilities include accounts payable and debt to banks or other borrowers. Net assets (assets minus liabilities) will equal stockholder’s equity. S/H equity + Liabilities = Assets.

Income Statement: The income statement shows where a company’s earnings came from, and what expenses they incurred in generated those earnings. You can use the income statement to find useful ratios such as margins (what percent of profit they keep) on their products, or what their effective tax rate is,

Cash Flow Statement: The cash flow statement shows where cash is being utilized throughout the company’s year or quarter. It breaks it down into segments of operational activities, financing activities, and investing activities, and shows the net inflows and outflows for each. This statement is great to calculate things like EBITDA (earnings before interest, taxes, depreciation and amortization), a common component of a discounted cash flow analysis.

Statement of Shareholder’s equity: The least common statement for investors, the statement of S/H equity (aka Statement of Retained Earnings) simply shows the balance of retained earnings for that period, plus any net income and less and dividends, and then gives the new balance for the retained earnings. All of this information can be gleaned from the other statements as well, so it’s not incredibly useful.

10-k: Aka the annual report, the 10-k is one of the most information-rich sources for investors. It covers all of the financial and operational results for that year, and has valuable sections like Section 7: Management Discussion & Analysis. We recommend you at least skim the 10-k for a company you are interested in buying.

10-q: The quarterly version of the 10-k, the 10-q is much shorter but still helps in understanding a company because it gives much more up-to-date data and results. Released at every quarter’s end.

8-k: Another important document, 8-k’s are used to inform investors of any non-schedule material changes in the company. Common reports can include quarterly earnings statements or revisions, change in management, or bigger events such as a bankruptcy filing.

13-g: This form is somewhat more rare, and must be filed by two parties at the same time. It signifies the acquisition of at least 5% of the public shares of a company. This is most often filed by bigger mutual funds who buy into a company, but the company itself must also file one. The reason we threw this one in here is because if you are interested in tracking hedge funds, these are the filings to watch for.

To search for these filings of a company directly, use the Securities and Exchange Commission’s EDGAR database. All companies are required to file with the SEC.

Investing Schools of Thought:

Value Investing: an investing “school of thought” for those who believe that, with a certain amount of research and due diligence, it is possible to find undervalued stocks that will regress to their ‘intrinsic value’ over the long run. Value investors believe that market dynamics (link) and overreactions will create opportunities for those who know where to look.

Special situations investing: this relatively small area of the investing world seeks to find opportunities in places of corporate distress or change. Events like bankruptcies, spinoffs, initial public offerings, mergers and acquisitions, restructurings, and rights offerings offer many events that can unlock value (or destroy it if you are not careful in your research). The reason special situations offer rewards is that many investors don’t bother looking or are mandated (in the case of institutional money like mutual funds) to avoid them. Irrationality on the part of most will offer benefits to a few who are willing to do their homework. Joel Greenblatt expounds on the wonders of special situations in his book, You Can Be a Stock Market Genius. Read our review of it here.

Technical analysis: This isn’t a school of though per se, but rather a technique used by many investors and traders alike to attempt to determine market timing. Technical analysis consists of studying charts that are based more on the stock price movements (technicals) rather than the actual characteristics of the company itself (fundamentals). While I think there are definitely some useful charts that can show you trends, there is certainly a lot of mumbo jumbo out there too (see example).