Quick-Start Investing – 5 Minute Investing Terms and Analysis

It’s easy enough to open an investing account these days but once that’s done, the question
becomes…how to invest?!?

There’s so much information online and on TV, where do you start and how do you know where
to put your money? From stock recommendations, predictions of crashes or zooming prices and
everything that passes for analysis – how do you cut through it all and actually get started
investing?

That’s what we’ll do in this handout, cut through all the jargon and complicated strategies for a
simple start to investing that you can do on your own. I’ll start with a quick checklist you can
use to compare stocks. Then we’ll look at a short list of terms for the beginner investor.

Let’s Do This!

Joseph Hogue, CFA

Let’s Talk Money!

P.S. If you want to see my complete process for picking stocks, check out the video here!

5-Minute Stock Analysis Checklist

Take you through the most important measures and ways to compare stocks. Don’t worry if
don’t understand some terms, I’ll include them in investing terms below.

• Sales growth is the first thing I check on a potential investment, how fast are they
growing sales on a year-over-year basis…if at all? If a company isn’t making higher sales
each year, it’s not going to grow profits even if it has a lot of the other measures I’m
looking for below. Find sales growth reported at the top of the company’s income
statement. (Note: I usually take this on a three-year annualized basis to find longer-term
growth)

Example: Apple reported $260.17 billion in sales last year and $215.64 billion in sales
three years ago. Sales growth (three-year annualized) = $260.17/$215.64 ^ 0.33 = 6.4%
annual growth.

• Operating margin is the operating income, so sales minus all the costs to run the
company, divided by the total sales. It’s the best measure of how well management is
doing to turn sales into profits. My single favorite measure to compare stocks, you can
 find this on the ‘Statistics’ page for a stock on Yahoo Finance or by taking the operating
income divided by sales.

Example: Apple reported sales of $260.17 billion over the last year and an operating
profit of $63.93 billion after all operating expenses. Operating margin = $63.93/$260.17
= 24.6%

• Payout ratio for dividend stocks is a great measure of how safe a dividend payment is
and how much room it has for growth. The payout ratio is the dividend amount divided
by earnings made by the company, usually both on an annual basis. Pay out too much
and there’s no room for growth or mistakes before the dividend is cut. Pay out too little
and it’s not much of a dividend stock!

Example: Apple pays a dividend of $0.77 each quarter or $3.08 per year and reported
earnings per share of $12.50 over the last year. Payout ratio = $3.08/$12.50 = 24.6%

Check out this video for more about the payout ratio and three risks in using it.

• Debt-to-Equity ratio is an important measure of financial flexibility and safety in a stock.

Take the amount of Long-term Debt and divide by the Stockholders’ Equity. This not
only tells you how much of the company is owned by stockholders and how much is
owed to creditors but also the level of risk in the shares.

Example: On the balance sheet, we see that Apple owes over $91.8 billion in long-term
debt against stockholders’ equity of $90.5 billion. Debt-to-Equity ratio = $91.8/$90.5 =
1.01
 • Price-to-Earnings to growth (PEG) ratio is a twist on the popular P/E ratio because it
includes earnings growth as well. It measures how expensive shares are for the level of
growth. Take the share price divided by earnings over the last year, then divide this
number by earnings growth as a whole number (i.e. growth of 25% would be 25).

Example: Apple trades at a price of $300 per share on earnings of $12 per share over the
last year for a PE ratio of 25-times. Earnings are expected to grow at 12.5% annually
over the next three years. PEG ratio = 25/12.5 = 2.0

Taken alone, these measures don’t really tell you much until you compare them against other
stocks and against the market. For example, you don’t know if an operating margin of 25% is
high or low until you see that the operation margin on another stock is 15%, which would tell
you that the first company’s management is more efficient at converting sales to profits.

You also need to remember here to always compare stocks within the same industry or sector
when using these measure. You can compare measures across sectors or against the stock
market as a whole but it isn’t as useful because of different business types. Comparing these
measures for a tech stock against a tech stock though will give you an apples-to-apples
comparison and help you pick the better investment.

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Terms Every Investor Should Know

• Price-to-Earnings ratio is the most popular investing measure and is simple the price per
share divided by the earnings (or net income) per share over the last four quarters. This
tells you how expensive the stock is relative to another PE ratio like that of another
stock, the overall market or the company’s own history of average PE ratios.
• Debt-to-Equity ratio shows how much of the company is owned by shareholders and
how much is owed to creditors. It’s a good measure of the risk in a stock and the
financial flexibility the company has if the economy heads into recession.

• Payout Ratio is the percentage of the profits paid out to shareholders with the dividend.
It’s a good measure of how sustainable the dividend is and if there’s room for growth.
Investors like to see a high dividend but the company also needs to save some profits
back to reinvest in growth and stay competitive.

• Operating Margin is a measure of how well management can turn sales into profits.
Operating income is the money left after paying suppliers and all operational expenses
to run the company. This income divided by the total sales is the operating margin, the
company’s operational efficiency.

Check out this video for seven must-see financial ratios to analyze investments

• Bear Market is technically when a stock’s price or a market index has fallen 20% or
more from its high. Sometimes the high is measured from the 52-week high and
sometimes it’s just the all-time high.

• Bull Market is any sustained increase in a stock’s price or the market more than three-
months. Sometimes it’s also when a stock price or the market has increased 10% off the
recent lows but there’s really no technical definition.

Watch this video for a history of bear and bull markets plus an investing strategy for each.

• Market Correction when a stock’s price or a market index falls 10% to 20% from its high.
Market corrections happen before a technical bear market but not all corrections turn
into a bear market.

• Dividend Yield is the dividend amount paid over the last four quarters divided by the
stock price. Example: Apple pays $3.08 a year dividend on a current price of $300 per
share for a 1.2% dividend yield.

• S&P 500 is the most widely used index to represent ‘the stock market’. It’s a grouping of
the 500 largest companies by market capitalization based in the United States.

• Net Income (Earnings or Profit) – also sometimes called ‘the bottom line’ because it
appears at the bottom of the Income Statement. Earnings are the ultimate ownership
for stockholders and are after all operating expenses, debt interest and taxes have been
taken out.
• Revenue (Sales) – also sometimes called ‘the top line’ because it appears at the top of
the Income Statement.

• Market Capitalization is the market value of a company, all its shares outstanding
multiplied by the price-per-share. Market cap can be broken into groups of company
sizes from Micro (from $50 to $300 million), Small (from $300 million to $2 billion), Mid-
cap (from $2 to $10 billion), Large (from $10 to $200 billion) and Mega (more than $200
billion).

• Exchange Traded Fund is a professionally-managed investment set up to follow a group

of stocks. ETFs can hold any asset class (stocks, bonds or real estate companies) and
hold anywhere from a few dozen stocks to thousands. They provide instant
diversification across companies in the group. ETFs charge an annual fee called an
Expense Ratio which is a percentage taken off fund assets each year to cover costs.

• Assets (also Asset Allocation) are a broad grouping of investments that share
fundamental characteristics. The main asset classes are stocks, bonds, real estate and
commodities of which all investors should have some exposure to in their portfolio.
Asset allocation is the split of these assets in your portfolio; i.e. 50% in stocks, 20% in
bonds and 30% in real estate. Asset allocation depends on your age, tolerance for risk
and other factors.

• Bonds are debt owed by a company with interest payments made twice a year and the
bond amount paid at the end of the investment. Also called Fixed Income because the
interest payment is usually a fixed amount. Bonds provide cash flow similar to dividends
but are safer than stocks because they are a debt obligation.

• Expense Ratio is the percentage charged by exchange traded funds (ETFs) to manage
the fund. It’s taken out of the fund assets, not out of your account but has the same
effect of lowering the ETF value. Always compare expense ratios for ETFs and lower is
usually better.

• Diversification is the idea of spreading your portfolio across different stocks, bonds and
other investments so your overall wealth does not depend on any one in particular. Also
applies within asset classes, so spreading your portfolio of stocks across 10+ company’s
shares so it is not at risk from one single company.

• IRA (also Roth IRA) are two types of retirement accounts. Deposits you make into an
IRA are tax-free in the year you make them though you pay income taxes on
withdrawals in retirement. Deposits into a Roth IRA are taxed as income in the year you
make them but then tax-free on withdrawal. Always max out your annual contribution
limit to either an IRA or a Roth, every year!
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You don’t need to be an financial expert or spend 40+ hours a week analyzing stocks to invest
your own money. Nobody will care as much about your money as you do and nobody will be as
thoughtful an investor. Keep control of your money and do your own investing.

I’m always here to answer any questions and help out any way I can. Let me know if you have
any questions or would like to see a topic in a video.

Thank You for being a part of the Bow-Tie Nation!