Often, terminology used in understanding markets and investing are unnecessarily confusing.
Our knowledge base will attempt to continually make sense of various terminology we use across Return On Time.
The Dow30, also known simply as the Dow, consist of 30 large, publicly-traded US companies.
The Dow was launchd in 1896 and is the second oldest stock market index in the United States.
Historically, the Dow was considered a simple way to track US stock market peformance. Today, the Dow likely does not as significantly represent the US economy relative to the S&P500 since the Dow measures 30 companies whereas the S&P500 measures 500 companies.
The Dow is a price-weighted index. This means that the 30 companies in the Dow are weighted based on their price per share, rather than their total value. As of August 11th, 2020, Apple is the highest priced stock in the Dow30 and thus makes up 11.13% of the index. At the bottom of the index, Pfizer is the lowest priced stock in the Dow30 and makes up 0.95% of the index.
Exchange Traded Fund (ETF)
An ETF, or Exchange Traded Fund, is a type of security that groups a number of securities, such as stocks. ETFs often track an underlying index, although they may invest in various industry sectors or utilize various strategies. ETFs are similar to Mutual Funds. However, ETFs tend to have lower fees than Mutual Funds usually and ETFs are listed on exchanges that trade like ordinary stocks.
ETFs can invest in various types of investments, such as stocks, bonds, commodities, or a mixture of both.
One of the most well known ETFs today is the SPY. Simply put, SPY tracks the S&P500 Index by investing in 500 S&P500 companies with the same weighting as the S&P500 index.
Historically, gold has been considered a form of currency. Until August 1971, the US dollar was also backed by gold. At that time, 1 oz. of gold was worth $35 US dollars. As of August 11th 2020, 1 oz. of gold is worth $1,904 US dollars.
Today, we operate in a fiat currency regime. A fiat currency is basically a currency that is not valued based on the price of a commodity like gold or silver. The value of fiat money is essentially a perceived value by the public and largely depends on almost unanimous faith in the government that issues that currency.
During recessions like the one in 2020, investors often flock to gold as a safe haven. In particular, due to the extreme money printing in 2020, gold has surged to new highs.
The Nasdaq100 is an index of the 100 largest, most actively traded US companies listed on the Nasdaq exchange. The Nasdaq is generally known as a technology focused index with nearly 100% of the index weighted towards tech and biotech companies.
Similar to the S&P, The Nasdaq Composite is a market-cap-weighted-index. This means that companies in the index are weighted based on the total market value of their outstanding shares. For example, as of August 11th, 2020, Apple is valued at $1.871T and as a result, 13.38% of the Nasdaq100 index is made up of Apple.
The S&P500, also known simply as the S&P, is a stock market index that measures the performance of 500 large companies listed on stock exchanges in the United States. The S&P500 is the most commonly followed and referenced stock index and is considered the best repesentation of the US stock market. Major companies like Amazon, Facebook, Microsoft, Alphabet, Visa, and JPMorgan are apart of the S&P500 index.
The S&P index is a cap-weighted index. This means that companies in the index are weighted based on the total market value of their outstanding shares. For example, as of August 11th, 2020, Microsoft is valued at $1.539T and as a result, 6% of the S&P500 index is made up of Microsoft.
Buybacks are an increasingly controversial strategy deployed by public companies to buy its own outstanding shares. By buying its own shares, a company reduces the number of outstanding shares available for purchase in the open/public market.
This practice helps a company achieve a few objectives:
1) When there are less shares outstanding, earnings per share (EPS) increases. This increases the financial performance of the company on paper, even if it is simply financial engineering.
2) By buying its own shares, a company returns money back to shareholders that own the stock. It’s like an infrequent dividend in that sense.
3) Lastly, when EPS increases, PE (price to earnings) ratio also decreases. Given that PE ratios are often used to quickly compute the valuation of a company, this also makes the company’s stock look cheaper.
So, in a very basic example, Company A has $100m USD in net income, 100m outstanding shares, and a stock price of $20. To calculate the Earnings Per Share (EPS), we will divide $100M net income by 100m shares. Company A has a $1 EPS. To calculate the Price To Earnings (PE) ratio, we divide the stock price ($20) by the EPS ($1) to arrive to a PE ratio of 20. Next year, the true financial results of the company are relatively flat with $100m USD in net income, 90m outstanding shares, and a stock price of $22. The company re-purchased (or bought back) 10m shares. As a result, the new EPS is $1.11 and the new PE ratio is 19.81. In this case, the company did not have any change in real income but did manage to boost its EPS and reduce its PE ratio.
After the Great Recession, buy backs became increasingly popular and a big driver for stock gains in the 2010-2020 timeline. Often times, instead of investing capital back into R&D (new ideas) or heavily into its people, capital and cheaply borrowed debt were used to buy back shares and artificially increase the performance of companies.
Value stocks are public companies trading at cheap valuations relative to their earnings and growth potential.
Generally speaking, most stocks are classified as either value stocks or growth stocks. Stocks that trade at below average valuations are typically considered value stocks, while stocks with above average growth rates are considered growth stocks.
Value stocks typically are mature businesses with decent growth rates and stable revenues/earnings. Most value stocks will pay a dividend.
Procter & Gamble, Johnson & Johnson, AT&T, and Verizon are examples of value stocks.