The Total Dollar value of a companies outstanding common stock, Market Capitalization = Shares Outstanding x Current Stock Price
$10,000,000,000 +, Low-Risk/Low-Reward
$10,000,000,000 - $2,000,000,000, Medium-Risk/Medium-Reward
$2,000,000,000 - $300,000,000, Higher-Risk/Higher Reward
A nationally recognized, well-established and financially sound company. Blue chips generally sell high-quality, widely accepted products and services. Blue chip companies are known to weather downturns and operate profitably in the face of adverse economic conditions, which helps to contribute to their long record of stable and reliable growth. The name "blue chip" came about because in the game of poker the blue chips have the highest value.
Enterprise Value (EV)
A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is calculated as market cap plus debt, minority interest and preferred shares, minus total cash and cash equivalents. Think of enterprise value as the theoretical takeover price. IN the event of a buyout, an acquirer would have to take on the company's debt, but would pocket its cash. EV differs significantly from simple market capitalization in several ways, and many consider it to be a more accurate representation of a firm's value. The value of a firm's debt, for example, would need to be paid by the buyer when taking over a company, thus EV provides a much more accurate takeover valuation because it includes debt in its value calculation.
A person or entity that owns more than 50% of a company's outstanding shares. The majority shareholders is often the founder of the company, or in the case of long-established businesses, the founder's descendants. By virtue of controlling more than half of the voting interests in the company, the majority shareholder has a very significant influence in the business operations and strategic direction of the company.
When one shareholder or a group acting in kind holds a high enough percentage of ownership in a company to enact changes at the highest level. By definition, this figure is 50% of the outstanding shares or voting shares, plus one. However, controlling interest can be achieved with less than 50% ownership of the stock if that person/group owns a significant proportion of the voting shares, because in many cases, not every share carries a vote in shareholder meetings.
An ownership stake in a corporation where the held position gives the investor no influence on how the company is run. The majority of investor positions are deemed to be a non-controlling interest because their ownership stake is so insignificant relative to the total number of outstanding shares. For smaller companies, any position that holds less than 50% of the outstanding voting shares is deemed to be a non-controlling interest.
A significant but non-controlling ownership of less than 50% of a company's voting shares by either an investor or another company. A non-current liability that can be found on a parent company's balance sheet that represents the proportion of its subsidiaries owned by minority shareholders.
In the investing world, it describes a method of calculating financial results in order to emphasize either current or projected figures. Pro Forma financial statements could be designed to reflect a proposed change, such as a merger or acquisition, or to emphasize certain figures when a company issues an earnings announcement to the public. Investors should be careful when reading a company's pro-forma financial statements, as the figure may not comply with generally accepted accounting principles (GAAP). In some cases, the pro-forma figures may differ greatly from those derived from GAAP.
An account that can be found in the assets portion of a company's balance sheet. Goodwill can often arise when one company is purchased by another company. In an acquisition, the amount paid for the company over the book value usually accounts for the target firm's intangible assets. Goodwill is seen as an intangible asset on the balance sheet because it is not a physical asset like buildings or equipment. Goodwill typically reflects the value of intangible assets such as a strong brand name, good customer relations, good employee relations and any patents or proprietary technology.
When goods are delivered to another company with the understanding that payment for the goods is only made once the goods are sold. Consignment can cover just about any type of business. It is advantageous for the seller of consigned goods, because they don't need to pay suppliers upfront.
The amount of profit that a company produces during a specific period, which is usually defined as a quarter (three calendar months) or a year. Earnings typically refer to after-tax net income. Ultimately, a business's earnings are the main determinant of its share price, because earnings and the circumstances relating to them can indicate whether the business will be profitable and successful in the long run. Earnings are perhaps the single most studied number in a company's financial statement because they show a company's profitability. A business's quarterly and annual earnings are typically compared to analyst estimates and guidance provided by the business itself. In most situations, when earnings do not meet either of those estimate, a business's stock price will tend to drop. On the other hand, when actual earnings beat estimates by a significant amount, the share price will likely surge.
An analyst's estimate for a company's future quarterly or annual earnings. Future earnings estimates are arguably the most important input when attempting to value a firm. By placing estimates on the earnings of a firm for certain periods (quarterly, annually, etc), analysts can then use cash flow analysis to approximate a fair value for a company, which in turn will give a target share price for publicly traded companies. Analysts use forecasting models, management guidance and fundamental information on the company in order to derive an estimate. Market participants rely heavily on earnings estimates to gauge a company's performance when announcing quarterly or annual results. The analysts' earnings estimates are used as a benchmark to measure a firm's performance relative to how experts expected it would do.
Earnings Per Share
The portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company's profitability. Calculated as: (Net Income - Dividends on Preferred Stock)/Average Outstanding Shares. When calculating, it is more accurate to use a weighted average number of shares outstanding over the reporting term, because the number of shares outstanding can change over time. However, data sources sometimes simplify the calculation by using the number of shares outstanding at the end of the period. Diluted EPS expands on the basic EPS by including the shares of convertibles or warrants outstanding in the outstanding shares number. Earnings per share is generally considered to be the single most important variable in determining a share's price. It is also a major component used to calculate the price-to-earnings valuation ratio. An important aspect of EPS that's often ignored is the capital that is required to generate the earnings (net income) in the calculation. Two companies could generate the same EPS number, but one could do so with less equity (investment) -- that company would be more efficient at using its capital to generate income and, all other things being equal, would be a "better" company. Investors also need to be aware of earnings manipulation that will affect the quality of the earnings number. It is important not to rely on any one financial measure, but to use it in conjunction with statement analysis and other measures.
A process, tool, system or similar item that is the property of a business or an individual that provides some sort of benefit or advantage to the owner. Companies that are able to develop useful proprietary technologies in-house are rewarded with a valuable asset: they can either use it exclusively or profit from the sale of licensing of their technology to other parties.
A basic good used in commerce that is interchangeable with other commodities of the same type. Commodities are most often used as inputs in the production of other goods or services. The quality of a given commodity may differ slightly, but it is essentially uniform across producers. When they are traded on an exchange, commodities must also meet specified minimum standards, also known as basis grade. The basic idea is that there is little differentiation between a commodity coming from one producer and the same commodity from another producer - a barrel of oil is basically the same product, regardless of the producer. Compare this to, say, electronics, where the quality and features of a given product will be completely different depending on the producer. Some traditional examples of commodities include grains, gold, beef, oil and natural gas. More recently, the definition has expanded to include financial products such as foreign currencies and indexes. Technological advances have also led to new types of commodities being exchanged in the marketplace: for example, cell phone minutes and bandwidth. The sale and purchase of commodities is usually carried out through futures contracts on exchanges that standardize the quantity and minimum quality of the commodity being traded. For example, the Chicago Board of Trade stipulates that one wheat contract is for 5,000 bushels and also states what grades of wheat (e.g. No. 2 Northern Spring) can be used to satisfy the contract.
The minimum accepted standard that a deliverable commodity must meet to be used as the actual of a futures contract. Also known as "par grade" or "contract grade". Basis grade is important for futures investors for maintaining uniformity, since a given commodity (e.g. oil) may vary drastically in quality. For example, the basis grade of crude futures contracts is set according to certain levels of hydrogen and sulfur in crude oil.
Refers to a company's net earnings, net income or earnings per shares (EPS). Bottom line also refers to any actions that may increase/decrease net earnings or a company's overall profit. A company that is growing its net earnings or reducing its costs is said to be "improving its bottom line". Most companies aim to improve their bottom lines through two simultaneous methods: growing revenues (i.e., generate top-line growth) and increasing efficiency (or cutting costs).
Projected earnings based on a set of assumptions and often used to present a business plan (in Latin pro forma means "fo the sake of form"). It also refers to earnings which exclude non-recurring items. Pro-forma earnings are not derived by standard GAAP methods. Items sometimes excluded in pro-forma earnings figures include write-downs, goodwill amortization, depreciation, restructuring and merger costs, interest, taxes, stock based employee pay and other expenses. The company excludes these items with the intent to present its figures more clearly to investors. However, whether or not this is accomplished is debatable. This has spawned such nicknames for pro-forma earnings as EEBS (earnings excluding bad stuff). Investors should be cautious looking at pro forma statements, they are not required to follow regulations that GAAP is, so positive pro forma numbers may become negative once GAAP is applied.
Generally Accepted Accounting Principles (GAAP)
The common set of accounting principles, standards and procedures that companies use to compile their financial statements. GAAP are a combination of authoritative standards (set by policy boards) and simply the commonly accepted ways of recording and reporting accounting information. GAAP are imposed on companies so that investors have a minimum level of consistency in the financial statements they use when analyzing companies for investment purposes. GAAP cover such things as revenue recognition, balance sheet item classification and outstanding share measurements. Companies are expected to follow GAAP rules when reporting their financial data via financial statements. If a financial statement is not prepared using GAAP principles, be very wary! That said, keep in mind that GAAP is only a set of standards. There is plenty of room within GAAP for unscrupulous accountants to distort figures. So, even when a company uses GAAP, you still need to scrutinize its financial statements.
A financial contract obligating the buyer to purchase an asset (or the seller to sell an asset), such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash. The futures markets are characterized by the ability to use very high leverage relative to stock markets. Futures can be used either to hedge or to speculate on the price movement of the underlying asset. For example, a producer of corn could use futures to lock in a certain price and reduce risk (hedge). On the other hand, anybody could speculate on the price movement of corn by going long or short using futures. The primary difference between options and futures is that options give the holder the right to buy or sell the underlying asset at expiration, while the holder of a futures contract is obligated to fulfill the terms of his/her contract. In real life, the actual delivery rate of the underlying goods specified in futures contracts is very low. This is a result of the fact that the hedging or speculating benefits of the contracts can be had largely without actually holding the contract until expiry and delivering the good(s). For example, if you were long in a futures contract, you could go short in the same type of contract to offset your position. This serves to exit your position, much like selling a stock in the equity markets would close a trade.
A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stock, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage. Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Derivatives are contracts and can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in particular region. Derivatives are generally used as an instrument to hedge risk, but can also be used for speculative purposes. For example, a European investor purchasing shares of an American company off of an American exchange (using U.S. dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into Euros.
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
An indicator of a company's financial performance which is calculated in the following EBITDA calcualtion: EBITDA = Revenue - Expenses (excluding tax, interest, depreciation, and amortization). EBITDA is essentially net income with interest, taxes, depreciation, and amortization added back to it, and can be used to analyze and compare profitability between companies and industries because it eliminates effects of financing and accounting decisions. This is a non-GAAP measure that allows a greater amount of discretion as to what is (and is not) included in the calculation. This also means that companies often change the items included in their EBITDA calculation from one reporting period to the next.
Earnings Before Interest & Taxes (EBIT)
An indicator of a company's profitability, calculated as revenue minus expenses, excluding tax and interest. EBIT is also referred to as "operating earnings", "operating profit" and "operating income", as you can rearrange the formula to be calculated as follows: EBIT = Revenue - Operating Expenses. Also known as Profit Before Interest & Taxes (PBIT), and equals Net Income with interest and taxes added back to it. In other words, EBIT is all profits before taking into account interest payments and income taxes. An important factor contributing to the widespread use of EBIT is the way in which it nulls the effects of the different capital structures and tax rates used by different companies. By excluding both taxes and interest expenses, the figure hones in on the company's ability to profit and thus makes for easier cross-company comparisons. EBIT was the precursor to the EBITDA calculation, which takes the process further by removing two non-cash items from the equation (depreciation and amortization).
Cash Earnings Per Share (Cash EPS)
A measure of financial performance that looks at the cash flow generated by a company on a per share basis. This differs from basic earnings per share (EPS), which looks at the net income of the company on a per share basis. The higher a company's cash EPS, the better it is considered to have performed over the period. A company's cash EPS can be used to draw comparisons to other companies or to the company's own past results. You may sometimes see cash EPS defined as either EPS plus amortization of goodwill and other intangible items, or net income plus depreciation divded by outstanding shares. Whatever the definition, the point of cash EPS is that it's a stricter number than other variations on EPS because cash flow cannot be manipulated as easily as net income.
A term that measures some aspect of a company's financial well-being, determined by dividing one metric by another metric. The metric in the numerator is typically larger than the one in the denominator, because the top metric is usually supposed to be many times larger than the bottom metric. Calculated as: Multiple = Performance Metric "A"/Performance Metric "B". For example, the term multiple can be used to show how much investors are willing to pay per dollar of earnings, as computed by the P/E ratio. Suppose you were analyzing a stock with a $2 of earnings per share (EPS) that is trading at $20 -- this stock would have a P/E of 10. This means investors are willing to pay a multiple of 10 times the current EPS for the stock.
An aggressively managed porfolio of investments that uses advanced investment strategies such as leveraged, long, short and derivative positions in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark). Legally, hedge funds are most often set up as private investment partnerships that are open to a limited number of investors and require a very large initial minimum investment. Investment in hedge funds are illiquid as they often require investors keep their money in the fund for at least one year. For the most part, hedge funds (unlike mutual funds) are unregulated because they cater to sophisticated investors. In the U.S., laws require that the majority of investors in the fund be accredited. That is, they must earn a minimum amount of money annually and have a net worth of more than $1 million, along with a significant amount of investment knowledge. You can think of hedge funds as mutual funds for the super rich. They are similar to mutual funds in that investments are pooled and professionally managed, but differ in that the fund has far more flexibility in its investment strategies. It is important to note that hedging is actually the practice of attempting to reduce risk, but the goal of most hedge funds is to maximize return on investment. The name is mostly historical, as the first hedge funds tried to hedge against the downside risk of a bear market by shorting the market (mutual funds generally can't enter into short positions as one of their primary goals). Nowadays, hedge funds use dozens of different strategies, so it isn't accurate to say that hedge funds just "hedge risk". In fact, because hedge fund managers make speculative investments, these funds can carry more risk than the overall market.
Hedge Fund Manager
The individual who oversees and makes decisions about the investments in a hedge fund. Managing a hedge fund can be an attractive career option because of its potential to be extremely lucrative. To be successful, a hedge fund manager must consider how to have a competitive advantage, a clearly defined investment strategy, adequate capitalization, a marketing and sales plan and a risk management strategy. Individuals wishing to invest in hedge funds must meet income and net worth requirements. Hedge funds can be considered high risk because they pursue aggressive investment strategies and are less regulated than many other types of investments. The hedge fund manager is responsible for the investment decision and the operations of the fund.
A reduction in earnings per share of common stock that occurs through the issuance of additional shares or the conversion of convertible securities. Adding to the number of shares outstanding reduces the value of holdings of existing shareholders.
Diluted Earnings Per Share (Diluted EPS)
A performance metric used to gauge the quality of a company's earnings per share (EPS) if all convertible securities were exercised. Convertible securities refer to all outstanding convertible preferred shares, convertible debentures, stock options (primary employee based) and warrants. Unless the company has no additional potential shares outstanding (a relatively rare circumstance) the diluted EPS will always be lower than the simple EPS. Remember that earnings per share is calculated by dividing the company's profit by the number of shares outstanding. Warrants, stock options, convertible preferred shares, etc. all serve to increasing the number of shares outstanding. As a shareholder, this is a bad thing. If the denominator in the equation (shares outstanding) is larger, the earnings per share is reduced (the same profit figure is used in the numerator). This is a conservative metric because it indicates somewhat of a worst-case scenario. On one hand, everyone holding options, warrants, convertible preferred shares, etc. is unlikely to convert their shares all at once. At the same time, if things go well, there is a good chance that all options and convertibles will be converted into common stock. A big difference in a company's EPS and diluted EPS can indicate high potential dilution for the company's shares, an attribute almost unanimously ostracized by analysts and investors alike.
Price-Earnings Ratio - P/E Ratio
A valuation ratio of a company's current share price compared to its per-share earnings. Calculated as: Market Value per Share/Earnings per Share (EPS). EPS is usually from the last four quarters (trailing P/E), but sometimes it can be taken from the estimates of earnings expected in the next four quarters (projected or forward P/E). A third valuation uses the sum of the last two actual quarters and the estimates of the next two quarters. Also sometimes known as "price multiple" or "earnings multiple". In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the whole story by itself. It's usually more useful to compare the P/E ratios of one company to other companies in the same industry, to the market in general or against the company's own historical P/E. It would not be useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a technology company (high P/E) to a utility company (low P/E) as each industry has much different growth prospects. The P/E is sometimes referred to as the "multiple", because is shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings. It is important that investors note an important problem that arises with the P/E measure, and to avoid basing a decision on this measure alone. The denominator (earnings) is based on an accounting measure of earnings that is susceptible to forms of manipulation, making the quality of the P/E only as good as the quality of the underlying earnings number.
Price/Earnings To Growth - PEG Ratio
A ratio used to determine a stock's value while taking into account earnings growth. The calculation is as follows: PEG = (P/E) / Anticipated Annual Earnings Per Share (EPS) growth. PEG is a widely used indicator of a stock's potential value. It is favored by many over the price/earnings ratio because it also accounts for growth. Similar to the P/E ratio, a lower PEG means that the stock is more undervalued. Keep in mind that the numbers used are projected and, therefore, can be less accurate. Also, there are many variations using earnings from different time periods (i.e. one year vs five year). Be sure to know the exact definition your source is using.
Price-To-Book Ratio - P/B Ratio
A ratio used to compare a stock's market value to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter's book value per share. Also known as the "price-equity ratio". A lower P/B ratio could mean that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company. As with most ratios, be aware that this varies by industry. This ratio also gives some idea of whether you're paying too much for what would be left if the company went bankrupt immediately.
The sale of securities to a relatively small number of select investors as a way of raising capital. Investors involved in private placements are usually large banks, mutual funds, insurance companies and pension funds. Private placement is the opposite of a public issue, in which securities are made available for sale on the open market. Since a private placement is offered to a few, select individuals, the placement does not have to be registered with the Securities and Exchange Commission. In many cases, detailed financial information is not disclosed and a the need for a prospectus is waived. Finally, since the placements are private rather than public, the average investor is only made aware of the placement after it has occurred.
A form of offering in the equity capital markets. It involves offering share in a short time period, will little to no marketing. The bookbuild of the offering is done very quickly in one or two days. Underwriters may sometimes guarantee a minimum price and proceeds to the firm. An accelerated bookbuild is often used when a company is in immediate need of financing and debt financing is out of the question. This can be the case when a firm is looking to make an offer to acquire another firm. For example, BetandWin.com used an accelerated bookbuild to raise between 200 and 300 million euros to help fund the acquisition of Ongame E-Solutions, the operator of pokerroom.com, one of the most popular poker websites.
A class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. Preferred stock generally has a dividend that must be paid out before dividends to common stockholders and the shares usually do not have voting rights. The precise details as to the structure of preferred stock is specific to each corporation. However, the best way to think of preferred stock is as a financial instrument that has characteristics of both debt (fixed dividends) and equity (potential appreciation). Also known as "preferred shares". There are certainly pros and cons when looking at preferred shares. Preferred shareholders have priority over common stockholders on earnings and assets in the event of liquidation and they have a fixed dividend (paid before common stockholders), but investors must weigh these positives against the negatives, including giving up their voting rights and potential for appreciation.
Types of Preferred Stock
Callable, Convertible, Participating, and Cumulative Preferred Stock
Callable Preferred Stock
A type of preferred stock that carries the provision that the issuer has the right to call in the stock at a certain price and retire it. Also known as "redeemable preferred stock". You can think of preferred stock as a security somewhere in-between stocks and bonds.
Convertible Preferred Stock
Preferred stock that includes an option for the holder to convert the preferred shares into a fixed number of common shares, usually anytime after a predetermined date. Also known as "convertible preferred shares". Most convertible preferred stock is exchange at the request of the shareholders, but sometimes there is a provision that allows the company (or issuer) to force conversion. The value of convertible common stock is ultimately based on the performance (or lack thereof) of the common stock.
Participating Preferred Stock
A type of preferred stock that gives the holder the right to receive dividends equal to the normally specified rate that preferred dividends receive as well as an additional dividend based on some predetermined condition. The additional dividend paid to preferred shareholders is commonly structured to be paid only if the amount of dividends that common shareholders receive exceeds a specified per-share amount. Furthermore, in the even of liquidation, participating preferred shareholders can also have the right to receive the stock's purchasing price back as well as pro-rata share of any remaining proceeds that the common shareholders receive.
Cumulative Preferred Stock
A type of preferred stock with a provision that stipulates that if any dividends have been omitted in the past, they must be paid out to preferred shareholders first, before common shareholders can receive dividends. A preferred stock will typically have a fixed dividend yield based on the par value of the stock. This dividend is paid out at set intervals, usually quarterly, to preferred holders. If a company runs into some financial problems and is unable to meet all of its obligations, it will likely suspend its dividend payments and focus on paying the business-specific expenses. If the company gets through the trouble and starts paying out dividends again, it will first have to pay back all of the dividends that are owed to preferred share holders.
Money provided by investors to startup firms and small businesses with perceived long-term growth potential. This is a very important source of funding for startups that do not have access to capital markets. It typically entails high risk for the investor, but it has the potential for above-average returns. Venture capital can also include managerial and technical expertise. Most venture capital comes from a group of wealthy investors, investment banks and other financial institutions that pool such investments or partnerships. This form of raising capital is popular among new companies or ventures with limited operating history, which cannot raise funds by issuing debt. The downside for entrepreneurs is that venture capitalists usually get a say in company decisions, in addition to a portion of the equity.
The process of determining the economic value of a business or company. Business valuation can be used to determine the fair value of a business for a variety of reasons, including sale value, establishing partner ownership and divorce proceedings. Often times, owners will turn to professional business valuators for an objective estimate of the business value. The field of business valuation encompasses a wide array of fields and methods. The tools and methods can vary between valuators, businesses and industries. Common approaches to business valuators include review of financial statements, discounting cash flow methods, and similar company comparisons.
Net Present Value (NPV)
Present Value (PV) of the Cash Flows discounted at WACC (there are exceptions).
Weighted Average Cost of Capital (WACC)
A calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources -- common stock, preferred stock, bonds and any other long-term debt -- are included in a WACC calculation. All else equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk. The WACC equation is the cost of each capital component multiplied by its proportional weight and then summing: WACC = [(E/V) Re] + [(D/V)Rd*(1-Tc)]. Where:
Re = Cost of equity
Rd = Cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V = E + D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = Corporate tax rate.
Businesses often discount cash flows at WACC to determine Net Present Value of a project. Broadly speaking, a company's assets are financed by either debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for each dollar it finances. A firm's WACC is the overall required return on the firm as a whole and, as such, it is often used internally by company directors to determine the economic feasibility of expansionary opportunities and mergers. It is the appropriate discount rate to use for cash flows with risk that is similar to that of the overall firm.
Defined by the International Project Finance Association (IPFA) as the following: The financing of long-term infrastructure, industrial projects and public services upon a non-recourse or limited recourse financial structure where project debt and equity used to finance the project are paid back from the cash flow generated by the project. In other words, project financing is a loan structure that relies primarily on the project's cash flow for repayment, with the project's assets, rights, and interests held as secondary security or collateral. Project finance is especially attractive to the private sector because they can fund major projects off balance sheet.
When a firm raises money for working capital or capital expenditures by selling bonds, bills, or notes to individual and/or institutional investors. In return for lending the money, the individuals or institutions become creditors and receive a promise that the principal and interest on the debt will be repaid. The other way of raising capital is to issue shares of stock in a public offering. This is called equity financing.
The act of raising money for company activities by selling common or preferred stock to individual or institutional investors. In return for the money paid, shareholders receive ownership interests in the corporation. Also known as "share capital". This is when a company raises money by issuing stock. The other way to raise money is through debt financing, which is when the company borrows money.
A mix of a company's long-term debt, specific short-term debt, common equity and preferred equity. The capital structure is how a firm finances its overall operations and growth by using different sources of funds. Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings. Short-term debt such as working capital requirements is also considered to be part of the capital structure. A company's proportion of short and long-term debt is considered when analyzing capital structure. When people refer to capital structure they are most likely referring to a firm's debt-to-equity ratio, which provides insight into how risky a company is. Usually a company more heavily financed by debt poses greater risk, as this firm is relatively highly levered.
Due Diligence (DD)
1. An investigation or audit of a potential investment. Due diligence serves to confirm all material facts in regard to a sale. Offers to purchase an asset are usually dependent on the results of due diligence analysis. This includes reviewing all financial records plus anything else deemed material to the sale. Sellers could also perform a due diligence analysis on the buyer. Items that may be considered are the buyer's ability to purchase, as well as other items that would affect the purchased entity or the seller after the sale has been completed. 2. Generally, due diligence refers to the care a reasonable person should take before entering into an agreement or a transaction with another party. Due diligence is a way of preventing unnecessary harm to either party involved in a transaction.
The process of determining the current worth of an asset or company. There are many techniques that can be used to determine value, some are subjective and others are objective. For example, an analyst valuing a company may look at the company's management, the composition of its capital structure, prospect of future earnings, and market value of assets. Judging the contributions of a company's management would be more of a subjective valuation technique, while calculating intrinsic value based on future earnings would be an objective technique.
A slang phrase that refers to the value of a company's stock before it goes public. The term is often by venture capitalists. Also known as "pre-money." For example let's say Jim's Fabless Donut Shop is thinking of going public. If management and venture capitalists estimate the company will raise $100 million in the IPO, it is said to have $100 million in pre-money. Valuing a company's stock before it goes public is a difficult task. When venture capitalists and entrepreneurs talk about pre-money they have to be very careful not to fall into the trap of "counting their chickens before the eggs have hatched" or, in other words, spending money they don't actually have.
A company's value after outside financing and/or capital injections are added to its balance sheet. Post-money valuation refers to a company's valuation after funds, such as investments from venture capitalists or angel investors have been added to the balance sheet. Valuations that are calculated before these funds are added are called pre-money valuations. The post-money valuation, then, is equal to the pre-money valuation plus the amount of any new equity received from outside sources such as investors. Investors such as venture capitalists and angel investors use pre-money valuations to determine the amount of equity they need to secure in exchange for any capital injection. For example, assume a company has a $100 million pre-money valuation. A venture capitalist puts $25 million into the company, creating a post-money valuation of $125 million (the $100 million pre-money valuation plus the investor's $25 million). In a very basic scenario, the investor would then have a 20% interest in the company, since $25 million is equal to one-fifth of the post-money valuation of $125 million.
A measure of a company's financial leverage calculated by dividing its total liabilities by stockholders' equity. It indicates what proportion of equity and debt the company is using to finance its assets. Debt/Equity Ratio = Total Liabilities / Shareholders' Equity. Note: sometimes only interest-bearing, long-term debt is used instead of total liabilities in the calculation. Also known as the Personal Debt/Equity Ratio, this ratio can be applied to personal financial statements as well as corporate ones. A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense. If a lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing. If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders benefit as more earnings are being spread among the same amount of shareholders. However, the cost of this debt financing may outweigh the return that the company generates on the debt through investment and business activities and become too much for the company to handle. This can lead to bankruptcy, which would leave shareholders with nothing. The debt/equity ratio also depends on the industry in which the company operates. For example, capital-intensive industries such as auto manufacturing tend to have a debt/equity ratio above 2, while personal computer companies have a debt/equity of under 0.5.
A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies. Mezzanine financing is basically debt capital that gives the lender the rights to convert to an ownership or equity interests in the company if the loan is not paid back in time and in full. It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies. Since mezzanine financing is usually provided to the borrower very quickly with little due diligence on the part of the lender and little or no collateral on the part of the borrower, this type of financing is aggressively priced with the lender seeking a return in the 20-30% range. Mezzanine financing is advantageous because it is treated like equity on a company's balance sheet and may make it easier to obtain standard bank financing. To attract mezzanine financing, a company usually must demonstrate a track record in the industry with an established reputation and product, a history of profitability and a viable expansion plan for the business (e.g. expansions, acquisitions, IPO).
A loan (or security) that ranks below other loans (or securities) with regard to claims on assets or earnings. Also known as a "junior security" or "subordinated loan". In the case of default, creditors with subordinated debt wouldn't get paid out until after the senior debtholders were paid in full. Therefore, subordinated debt is more risky than unsubordinated debt.
A loan or security that ranks above other loans or securities with regard to claims on assets or earnings. Also known as a senior security. In the case of default, creditors with unsubordinated debt would get paid out in full before the junior debt holders. Therefore, unsubordinated debt is less risky than subordinated debt.
1. The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment. Leverage can be created through options, futures, margin and other financial instruments. For example, say you have $1,000 to invest. This amount could be invested in 10 shares of Microsoft stock, but to increase leverage, you could invest the $1,000 in five options contracts. You would then control 500 shares instead of just 10. 2. The amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged. Most companies use debt to finance operations. By doing so, a company increases its leverage because it can invest in business operations without increasing its equity. For example, if a company formed with an investment of $5 million from investors, the equity in the company is $5 million -- this is the money the company uses to operate. If the company uses debt financing by borrowing $20 million, the company now has $25 million to invest in business operations and more opportunity to increase value for shareholders. Leverage is most commonly used in real estate transactions through the use of mortgages to purchase a home. Leverage helps both the investor and the firm to invest or operate. However, it comes with greater risk. If an investor uses leverage to make an investment and the investment moves against the investor, his or her loss is much greater than it would've been if the investment had not been leveraged -- leverage magnifies both gains and losses. In the business world, a company can use leverage to try to generate shareholder wealth, but if it fails to do so, the interest expense and credit risk of default destroys shareholder value.
1. The actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value. Value investors use a variety of analytical techniques in order to estimate the intrinsic value of securities in hopes of finding investments where the true value of the investment exceeds its current market value. For example, value investors that follow fundamental analysis look at both qualitative (business model, governance, target market factors etc.) and quantitative (ratios, financial statement analysis, etc.) aspects of a business to see if the business is currently out of favor with the market and is really worth much more than its current valuation. 2. For call options, this is the difference between the underlying stock's price and the strike price. For put options, it is the difference between the strike price and the underlying stock's price. In the case of both puts and calls, if the respective difference value is negative, the intrinsic value is given as zero. Intrinsic value in options is the in-the-money portion of the option's premium. For example, if a call options strike price is $15 and the underlying stock's market price is at $25, then the intrinsic value of the call options is $10. An option is usually never worth less than what an option holder can receive if the option is exercised.
The difference between an option's market price and its intrinsic value. In theory, options should not trade above their intrinsic value due to the time value associated with options pricing. Extrinsic value is also the portion of an item's worth that is assigned to it by external factors. The opposite of extrinsic value is intrinsic value, which is the inherent worth of an item. For example, an option that has a premium price of $10 and an intrinsic value of $6 would have an extrinsic value of $4. Denoting the amount by which the option's price is greater than the intrinsic value, all else equal, the extrinsic value of the option declines as its expiration date draws closer. A piece of residential real estate would have intrinsic value based on factors such as its age, condition, square footage and location. The fact that it is the seller's childhood home is part of the home's extrinsic value, and will not be factored into the price a buyer will pay for the home. In this situation, the extrinsic value of the home cannot be conveyed to any buyer except, perhaps, another family member.
The process of evaluating businesses, projects, budgets and other finance-related entities to determine their suitability for investment. Typically, financial analysis is used to analyze whether an entity is stable, solvent, liquid, or profitable enough to be invested in. When looking at a specific company, the financial analyst will often focus on the income statement, balance sheet, and cash flow statement. In addition, one key area of financial analysis involves extrapolating the company's past performance into an estimate of the company's future performance. One of the most common ways of analyzing financial data is to calculate ratios from the data to compare against those of other companies or against the company's own historical performance. For example, return on assets is a common ratio used to determine how efficient a company is at using its assets and as a measure of profitability. This ratio could be calculated for several similar companies and compared as part of a larger analysis.
Securities analysis that uses subjective judgment based on nonquantifiable information, such as management expertise, industry cycles, strength of research and development, and labor relations. This type of analysis technique is different than the quantitative analysis, which focuses on numbers. The two techniques, however, will often be used together. While most investors and analysts rely largely on quantitative measures, metrics such as the debt-to-equity and price-to-equity ratios, supplementing the analysis with qualitative analysis increases the insight into the company. Using qualitative factors will often give analysts an edge since key factors, such as management, does not show up in quantitative analysis. To help you remember, qualitative = qualities of a company.
A business or financial analysis technique that seeks to understand behavior by using complex mathematical and statistical modeling, measurement and research. By assigning a numerical value to variables, quantitative analysts try to replicate reality mathematically. Quantitative analysis can be done for a number of reasons such as measurement, performance evaluation or valuation of a financial instrument. It can also be used to predict real world events such as changes in a share price. In broad terms, quantitative analysis is simply a way of measuring things. Examples of quantitative analysis include everything from simple financial ratios such as earnings per share, to something as complicated as discounted cash flow, or option pricing. Although quantitative analysis is a powerful tool for evaluating investments, it rarely tells a complete story without the help of its opposite -- qualitative analysis. In financial circles, quantitative analysts are affectionately referred to as "quants", "qaunt jockeys" or "rocket scientists".
A method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity. Technical analysts believe that the historical performance of stocks and markets are indications of future performance. In a shopping mall, a fundamental analyst would go to each store, study the product that was being sold, and then decide whether to buy it or not. By contrast, a technical analyst would sit on a bench in the mall and watch people go into the stores. Disregarding the intrinsic value of the products in the store, the technical analyst's decision would be based on the patterns or activity of people going into each store.
A method of evaluating a security that entails attempting to measure its intrinsic value by examining related economic, financial and other qualitative and quantitative factors. Fundamental analysts attempt to study everything that can affect the security's value, including macroeconomic factors (like the overall economy and industry conditions) and company-specific factors (like financial condition and management). The end goal of performing fundamental analysis is to produce a value that an investor can compare with the security's current price, with the aim of figuring out what sort of position to take with that security (underpriced = buy, overpriced = sell or short). This method of security analysis is considered the opposite of technical analysis. Fundamental analysis is about using real data to evaluate a security's value. Although most analysts use fundamental analysis to value stocks, this method of valuation can be used for just about any type of security. For example, an investor can perform fundamental analysis on a bond's value by looking at economic factors, such as interest rates and the overall state of the economy, and information about the bond issuer, such as potential changes in credit ratings. For assessing stocks, this method uses revenues, earnings, future growth, return on equity, profit margins and other data to determine a company's underlying value and potential for future growth. In terms of stocks, fundamental analysis focuses on the financial statements of the company being evaluated. One of the most famous and successful fundamental analysts is the Oracle of Omaha, Warren Buffett, who is well known for successfully employing fundamental analysis to pick securities. His abilities have turned him into a billionaire.
Levered Free Cash Flow
The amount of cash that is left over for stockholders after interest on company debt has been paid out. Levered free cash flow plays an integral role in a business because cash can be used to pay dividends, pay for expansion or take on more debt for growth opportunities. Levered free cash flows are important to a company because it signals what sort of cash position it is in after interest on its debt has bee paid out. For example, if a company generates large quantities of cash, most of which has to be used to pay off interest on debt, the cash generated might not be enough to sustain proper future operations.
Unlevered Free Cash Flow - UFCF
A company's cash flow before interest payments are taken into account. Unlevered free cash flow can be reported in a company's financial statements, and shows how much cash is on hand to pay for operations before other financial obligations are taken into account. Unlevered Free Cash Flow = EBITDA - CAPEX - Working Capital - Taxes. The smaller the gap between unlevered cash flow and leveraged cash flow, the smaller amount of unobligated cash the company has on hand, and the company is more likely to run into problems if revenue streams dry up. A company that has a large amount of outstanding debt -- one that is highly "leveraged" -- is more likely to report unlevered free cash flow because it provides a rosier picture of the company's financial health. The figure shows how assets are performing in a vacuum, because it ignores the payments made for debt incurred to obtain those assets. Investors have to make sure to take into account debt obligations, since highly leveraged companies are at greater risk for bankruptcy.
Out of The Money - OTM
A call option with a strike price that is higher than the market price of the underlying asset, or a put option with a strike price that is lower than the market price of the underlying asset. An out of the money option has no intrinsic value, but only possesses extrinsic or time value. As a result, the value of an out of the money option erodes quickly with time as it gets closer to expiry. If it is still out of the money at expiry, the option will expire worthless.
At The Money
A situation where an option's strike price is identical to the price of the underlying security. Both call and put options will be simultaneously "at the money". For example, if XYZ stock is trading at 75, then XYZ 75 call option is at the money and so is the XYZ 75 put option. An at-the-money option has no intrinsic value, but may still have time value. Options trading activity tends to be high when options are at the money. "At the money" is one of three terms used to describe the relationship between an option's strike price and the underlying security's price, or option "moneyness". The other two are "in the money," meaning the option has some intrinsic value, and "out of the money", meaning the option has no intrinsic value. Also, sometimes the term "near the money" is used to describe an option that is within 50 cents of being at the money.
In The Money
1. For a call option, when the option's strike price is below the market price of the underlying asset. 2. For a put option, when the strike price is above the market price of the underlying asset. Being in the money does not mean you will profit, it just means the options is worth exercising. This is because the option costs money to buy. In the money means that your stock option is worth money and you can turn around and sell or exercise it.
A measure of both a company's efficiency and its short-term financial health. The working capital ratio is calculated as: Working Capital = Current Assets - Current Liabilities. Positive working capital means that the company is able to pay off its short-term liabilities. Negative working capital means that a company currently is unable to meet its short-term liabilities with its current assets (cash, accounts receivable, and inventory). Also known as "net working capital", or the "working capital ratio". If a company's current assets do not exceed its current liabilities, then it may run into trouble paying back creditors in the short term. The worst-case scenario is bankruptcy. A declining working capital ratio over a longer time period could also be a red flag that warrants further analysis. For example, it could be that the company's sales volumes are decreasing and, as a result, its accounts receivables number continues to get smaller and smaller. Working capital also gives investors an idea of the company's underlying operational efficiency. Money that is tied up in inventory or money that customers still owe to the company cannot be used to pay off any of the company's obligations. So, if a company is not operating in the most efficient manner (slow collection), it will show up as an increase in the working capital. This can be seen by comparing the working capital from one period to another; slow collection may signal an underlying problem in the company's operations.
Free Cash Flow (FCF)
A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt. FCF is calculated as: EBIT*(1-Tax Rate) (Net Income) - Change in Net Working Capital (Current Assets - Current Liabilities) - Capital Expenditure + Non-Cash Charges (Depreciation & Amortization). It can also be calculated by taking operating cash flow and subtracting capital expenditures. Some believe that Wall Street focuses myopically on earnings while ignoring the "real" cash that a firm generates. Earnings can often be clouded by accounting gimmicks, but it's tougher to fake cash flow. For this reason, some investors believe that FCF gives a much clearer view of the ability to generate cash (and thus profits). It is important to note that negative free cash flow is not bad in itself. If free cash flow is negative, it could be a sign that a company is making large investments. If these investments earn a high return, the strategy has the potential to pay off in the long run.
A type of investing or budgeting style for which real return rates or periodic income is received at regular intervals at reasonably predictable levels. Fixed-income budgeters and investors are often one and the same - typically retired individuals who rely on their investments to provide a regular, stable income stream. This demographic tends to invest heavily in fixed-income investments because of the reliable returns they offer. Individuals who live on set amounts of periodically paid income face the risk that inflation will erode their spending power. Fixed-income investors receive set, regular payments that face the same inflation risk. The most common type of fixed-income security is the bond; bonds are issued by federal governments, local municipalities or major corporations.
Traditionally, the exchange of one security for another to change the maturity (bonds), quality of issues (stocks or bonds), or because investment objectives have changed. Recently, swaps have grown to include currency swaps and interest rate swaps. If firms in separate countries have comparative advantages on interest rates, then a swap could benefit both firms. For example, one firm may have a lower fixed interest rate, while another has access to a lower floating interest rate. These firms could swap to take advantage of the lower rates.
1. The difference between the negotiated and fixed rate of a swap. The spread is determined by characteristics of market supply and worthiness. 2. The difference between the swap rate and the lending rate offered through other investment vehicles with comparable characteristics. Similar to equity spreads, the swap spread adjusts for every contract and the different participating parties.
A person who trades derivatives, commodities, bonds, equities, or currencies with a higher-than-average risk in return for a higher-than-average profit potential. Speculators take large risks, especially with respect to anticipating future price movements, in hope of making quick, large gains. Speculators are typically sophisticated, risk-taking investors with expertise in the market(s) in which they are trading and will usually use highly leveraged investments such as futures and options.
The process of identification, analysis and either acceptance or mitigation of uncertainty in investment decision-making. Essentially, risk management occurs anytime an investor or fund manager analyzes and attempts to quantify the potential for losses in an investment and then takes the appropriate action (or inaction) given their investment objectives and risk tolerance. Inadequate risk management can result in severe consequences for companies as well as individuals. For example, the recession that began in 2008 was largely caused by the loose credit risk management of financial firms. Simply put, risk management is a two-step process - determining what risks exist in an investment and then handling those risks in a way best-suited to your investment objectives. Risk management occurs everywhere in the financial world. It occurs when an investor buys low-risk government bonds over more risky corporate debt, when a fund manager hedges their currency exposure with currency derivatives and when a bank performs a credit check on an individual before issuing them a personal line of credit.
A line that is drawn over pivot highs or under pivot lows to show the prevailing direction of price. Trendlines are a visual representation of support and resistance in any time frame. Trendlines are used to show direction and speed of price. Trendlines also describe patterns during periods of price contraction.
An uptrend line has a positive slope and is formed by connecting two or more low points. The second low must be higher than the first for the line to have a positive slope. Uptrend lines act as support and indicate that net-demand (demand less supply) is increasing even as the price rises. A rising price combined with increasing demand is very bullish, and shows a strong determination on the part of the buyers. As long as prices remain above the trend line, the uptrend is considered solid and intact. A break below the uptrend line indicates that net-demand has weakened and a change in trend could be imminent.
A downtrend line has a negative slope and is formed by connecting two or more high points. The second high must be lower than the first for the line to have a negative slope. Downtrend lines act as resistance, and indicate that net-supply (supply less demand) is increasing even as the price declines. A declining price combined with increasing supply is very bearish, and shows the strong resolve of the sellers. As long as prices remain below the downtrend line, the downtrend is solid and intact. A break above the downtrend line indicates that net-supply is decreasing and that a change of trend could be imminent.
The amount by which the ask price exceeds the bid. This is essentially the difference in price between the highest price that a buyer is willing to pay for an asset and the lowest price for which a seller is willing to sell it. For example, if the bid price is $20 and the ask price is $21 then the "bid-ask spread" is $1. The size of the spread from one asset to another will differ mainly because of the difference in liquidity of each asset. For example, currency is considered the most liquid asset in the world and the bid-ask spread in the currency market is one of the smallest (one-hundredth of a percent). On the other hand, less liquid assets such as small-cap stock may have spreads that are equivalent to a percent of two or more of the asset's value.
A financial ratio that shows how much a company pays out in dividends each year relative to its share price. In the absence of any capital gains, the dividend yield is the return on investment for a stock. Dividend yield is calculated as follows: Annual Dividends Per Share / Price Per Share. Dividend yield is a way to measure how much cash flow you are getting for each dollar invested in an equity position - on other words, how much "bang for your buck" you are getting from dividends. Investors who require a minimum stream of cash flow from their investment portfolio can secure this cash flow by investing in stock paying relatively high, stable dividend yields.
Capital Gains Yield
The price appreciation component of a security's (such as common stock) total return. For stock holdings, the capital gains yield will be the change in price divided by the original (purchase) price. Calculated as: Capital Gains Yield = (P1-P0)/P0. Where: P0 = Original price of the security, P1 = Current/selling price of the security. It is important to analyze both the capital gains yield and total return yield of an investment holding. Dividends are not to be counted in a capital gains yield assessment, but keep in mind that depending on the stock, dividends could comprise a substantial portion of the total return of the stock comprised to capital gains.
Compound Annual Growth Rate (CAGR)
The year-over-year growth rate of an investment over a specified period of time. The compound annual growth rate is calculated by taking the nth root of the total percentage growth rate, where n is the number of years in the period being considered. This can be written as follows: CAGR = [(Ending Value/Beginning Value) ^ (1 / # of Years)] - 1. CAGR isn't the actual return in reality. It's an imaginary number that describes the rate at which an investment would have grown if it grew at a steady rate. You can think of CAGR as a way to smooth out the returns.
Annual Percentage Rate (APR)
The annual rate that is charged for borrowing (or made by investing), expressed as a single percentage number that represents the actual yearly cost of funds over the term of a loan. This includes any fees or additional costs associated with the transaction. Loans or credit agreements can vary in terms of interest-rate structure, transaction fees, late penalties and other factors. A standardized computation such as the APR provides borrowers with a bottom-line number they can easily compare to rates charged by other potential lenders. By law, credit card companies and loan issuers must show customers the APR to facilitate a clear understanding of the actual rates applicable to their agreements. Credit card companies are allowed to advertise interest rates on a monthly basis (e.g. 2% per month), but are also required to clearly state the APR to customers before any agreement is signed. For example, a credit card company might charge 1% a month, but the APR is 1% x 12 months = 12%. This differs from annual percentage yield, which also takes compound interest into account. APR = Periodic Rate x Number of Periods.
Annual Percentage Yield (APY)
The effective annual rate of return taking into account the effect of compounding interest. APY = [(1+Periodic Rate)^Number of Periods] - 1. The resultant percentage number assumes that funds will remain in the investments vehicle for a full 365 days. The APY is similar in nature to the annual percentage rate. Its usefulness lies in its ability to standardize varying interest-rate agreements into an annualized percentage number.
Periodic Interest Rate
The interest rate charged on a loan or realized on an investment over a specific period of time. Most interest rates are quoted on an annual basis. If the interest on the loan or investment compounds more frequent than annually, the annual interest rate must be converted to a period interest rate where interest charged or realized over each compounding period can be calculated. This calculation is made by dividing the annual interest rate by the number of compounding periods.
A profit that exists on paper, resulting from any type of investment. An unrealized gain is a profitable position that has yet to be cashed in, such as a winning stock position that remains open. A gain becomes realized once the position is closed for a profit. An unrealized loss, on the other hand, occurs when an investor is holding onto a losing investment, such as a stock that has dropped in value since the position has opened. A loss becomes realized once the position is closed for a loss. Unrealized gains and unrealized losses are often called "paper" profits or losses, since the actual gain or loss is not determined until the position is closed. In general, capital gains are taxed only when they become realized.
A gain resulting from selling an asset at a price higher than the original purchase price. Realized gain occurs when an asset is disbursed at a level that exceeds its cost of book value. While an asset may be carried on a balance sheet at a level far above cost, any gains while the asset is still being held would be considered unrealized, as the asset is only being valued at a fair market value.
A loss that results from holding onto an asset after it has decreased in price, rather than selling it and realizing the loss. An investor may prefer to let a loss go unrealized in the hope that the asset will eventually recover in price, thereby at least breaking even or posting a marginal profit. For tax purposes, a loss needs to be realized before it can be used to offset capital gains.
A loss is recognized when assets are sold for a price lower than the original purchase price. Realized loss occurs when an asset which was purchased at a level referred to as cost or book value is then disbursed for a value below its book value. Although the asset may have been held on the balance sheet at a fair value level below cost, the loss only becomes realized once the asset is off the books. One upside to a realized loss is the possible tax advantage. In most instances a portion of the realized loss may be applied against a capital gain or realized profit to reduce taxes. This may be quite desirable for a company looking to limit its tax burden, and firms may actually go out of their way to realize losses in periods where their tax bill is expected to be higher than wished.
The partial or full disposal of an investment or asset through sale, exchange, closure or bankruptcy. Divestiture can be done slowly and systematically over a long period of time, or in large lots over a short time period. For a business, divestiture is the removal of assets from the books. Businesses divest by the selling of ownership stakes, the closure of subsidiaries, the bankruptcy of divisions, and so on. In personal finance, investors selling shares of a business can be said to be divesting their interests in the company being sold.
Getting rid of an asset or security through a direct sale or some other method. Quite often you will see insider report a "disposition" of a certain number of shares, this just means that they sold them.
The risk inherent to the entire market or entire market segment. Also known as "un-diversifiable risk" or "market risk". Interest rates, recession and wars all represent sources of systematic risk because they affect the entire market and cannot be avoided through diversification. Whereas this type of risk affects a broad range of securities, unsystematic risk affects a very specific group of securities or an individual security. Systematic risk can be mitigated only by being hedged. Even a portfolio of well-diversified assets cannot escape all risk.
Company or industry specific risk that is inherent in each investment. The amount of unsystematic risk can be reduced through appropriate diversification. Also known as "specific risk," "diversifiable risk" or "residual risk". For example, news that is specific to a small number of stocks, such as a sudden strike by the employees of a company you have shares in, is considered to be unsystematic risk.
The creation of an independent company through the sale or distribution of new shares of an existing business/division of a parent company. A spinoff is a type of divestiture. Businesses wishing to 'streamline' their operations often sell less productive, or unrelated subsidiary businesses as spinoffs. The spun-off companies are expected to be worth more as independent entities than as parts of a larger business.
A means of reorganizing an existing corporate structure in which the stock of a business division, subsidiary or newly affiliated company is transferred to the stockholders of the parent company in exchange for stock in the latter. Split-offs often occur when the parent company wishes to draw a greater distinction between itself and the split-off business. It is probably wise to treat split-offs with suspicion, as companies will often use them to bolster the balance sheet by shedding underperforming or unprofitable divisions and/or subsidiaries.
A corporate action in which a single company splits into two ore more separately run companies. Shares of the original company are exchanged for shares in the new companies, with the exact distribution of shares depending on each situation. This is an effective way to break up a company into several independent companies. After a split-up, the original company ceases to exist. A company can split up for many reasons, but it typically happens for strategic reasons or because the government mandates it. Some companies have a broad range of business lines, often completely unrelated. This can make it difficult for a single management team to maximize the profitability of each line. It can be much more beneficial to shareholders to split up the company into several independent companies, so that each line can be managed individually to maximize profits. The government can also force the splitting up of a company, usually due to concerns over monopolistic practices. In this situation, it is mandatory that each segment of a company that is split up be completely independent from the others, effectively ending the monopoly.
Sometimes known as a partial spinoff, a carve out occurs when a parent company sells a minority (usually 20% or less) stake in a subsidiary for an IPO or rights offering. Also, when an established brick-and-mortar company hooks up with venture investors and a new management team to launch an Internet spinoff. In most cases the parent company will spinoff the remaining interests to existing shareholders at a later date when the stock price is much higher. Also known as a "carve out" or an "equity carve out".
The acquisition of one company (called the target company) by another (called the acquirer) that is accomplished not by coming to an agreement with the target company's management, but by going directly to the company's shareholders or fighting to replace management in order to get the acquisition approved. A hostile takeover can be accomplished through either a tender offer or a proxy fight. The key characteristic of a hostile takeover is that the target company's management does not want the deal to go through. Sometimes a company's management will defend against unwanted hostile takeovers by using several controversial strategies including the poison pill, crown-jewel defense, golden parachute, pac-man defense, and others.
Hostile Takeover Bid
An attempt to take over a company without the approval of the company's board of directors. When vying for control of a publicly-traded firm, the acquirer attempting the hostile takeover may proceed to bypass board approval in one of two ways typically. First, the acquirer may attempt to buy enough shares of the company in order to acquire a controlling interest in the firm. Second, the acquirer may instead try to persuade existing shareholders to vote in a new board which will accept the takeover offer.