What those confusing investing terms really mean

Sam Meadows 15th Nov 2021 No Comments

Reading Time: 7 minutes

You might feel like the wolf of Wall Street when you set out trying to invest for the first time, but if you’re like most people then you will quickly be bamboozled by the complicated array of words and numbers, those confusing investing terms, you see before you on your screen.

Phrases like the ‘price-to-earnings ratio’ and ‘market capitalisation’ almost seem designed to put off amateur investors.

But do not be deterred, the nuts and bolts of investing is relatively simple – once you can tell your revenue from your profit-before-tax.

This guide will run you through what the basic terms mean and, crucially, which ones are the most important to pay attention to. You’ll be feeling like Warren Buffett in no time!

• Why invest
• How to invest?
• Knowing your dividend yields from your P/E ratios
• But what should I pay attention to?

 

Why invest

If you’ve been forlornly watching the interest rate on your savings account fall lower and lower in recent years then you will already have an idea of the answer.

Although, by definition, riskier than putting your nest egg in a regular savings account and leaving it alone, investing could lead to much higher returns in the long term.

While the best easy-access savings account paid just 0.65% in interest, at the time of writing the FTSE 100, which is made up of the UK’s biggest companies, had returned 23% to investors.

Over the long-term this has been even higher, making investing an important part of any long-term savings strategy.

However, it almost goes without saying that investing comes with risk attached. While money kept in a normal savings account is protected in the event that your bank or provider goes bust, the same is not true of money held in stocks or funds. If the value of your holdings fall, then so does the value of your investment.

Thankfully, there are some simple strategies out there that can lessen this risk. This guide will touch on these but is mainly focused on decoding the little-known terms and definitions you will need to know.

How to invest?

In order to get started investing your cash you will need a specific type of account. Although a few types exist, most starter investors should open a stocks and shares Isa.

This allows savers to put away up to £20,000 a year and any interest or profit made is tax-free. (Note that the £20,000 limit applies across all of your Isas, so if you are also saving into a lifetime Isa, for example, then your limit will be reduced in your stocks and shares Isa.)

You will need to open an account with a stockbroker. Some of the most well-known are Hargreaves Lansdown, AJ Bell and Interactive Investor, but there are numerous other app-based services now available like Nutmeg or Moneybox.

After registering your personal details you can buy stocks or funds on the platform. The platform will charge a fee for this service, usually between 0.25% and 0.45%, while any investments you choose will likely come with an additional charge.

You should compare the cost of trading on a number of platforms to ensure you are getting the best deal.

Knowing your dividend yields from your P/E ratios

So you’ve decided you want to invest, you’ve chosen a platform and opened an account and you’ve put some money in ready to go.

You go online to look for something to invest in but are quickly met with a baffling series of terms and numbers you’ve never seen before.

Don’t worry, you’re not alone. Sometimes it can feel like the industry is intentionally making it hard to get your head round it all!

The next section of this guide covers an array of common phrases you will come across in your investing adventure and try and help you understand what they mean.

performance

This is likely to be one of the first things you will look at when considering an investment. This shows the growth or fall in the value of a share over a number of time periods. Remember that a fall over the past week or month should not necessarily be alarming. Investing is a long-term game and you should be prepared to leave your money alone for a number of years.

Year-to-date

This is used to show that performance is being measured from the start of the calendar year to the current date, as opposed to over the past 12 months. Be aware of this if you are looking at stock performance very early in the year.

Revenue/profit-before-tax

The amount of money made by a company from its normal business activities. Profit is the amount of money made after outgoings.

Open

This is simply the price of the given stock at the time the market opened that day. The opening time for markets across the world differs, but the London Stock Exchange opens at 8am Monday to Friday.

Previous close

 This is the price of the given stock at the time the market closed the night before, and will often be closely followed by…

Previous

This is the change in stock price, in percentage terms, over the course of the previous day’s trading. A positive number mean the stock became more valuable over that day, while a negative number means the price fell.

Trade high/low

This represents the highest and lowest price the stock was valued at on the most recent day of trading. These numbers will usually be broadly similar. A vast difference could be a signal of volatility.

Volatility

Volatility represents the range of price changes in a stock’s value over a given time period. While high volatility is usually seen as a bad sign, it is a little more complicated and some seasoned investors will see high volatility as an opportunity for profit. If you are new to investing though you will probably want to steer clear of highly volatile stocks.

Volume

This is just the number of shares in a given stock traded on the most recent day of trading.

Year high/low

The highest and lowest price of a stock in the past 52 weeks. This can give you an idea of the general direction a stock price has been heading in, but, as always in investing, past performance is not necessarily an adequate signal for performance in the future.

Dividends and dividend yield

For stock investors this is a really important term to get your head around. Most stocks pay dividends, a regular payment to shareholders, usually connected to the performance of the given company. Dividends will be paid per share held, so if the dividend is $5 and a shareholder has one share then they will receive $5. If they have 20 shares, then they will receive $100. The dividend yield represents the amount paid out in the most recent annual dividend as a percentage of the company’s stock price. This gives an investor an idea of the expected annual return on the money invested (but does not include increases and falls in the share price itself). This will be particularly important for people who plan to live off the income from their dividends, a common technique among retirees with large holdings.

Market capitalisation

This is just the total value of the company. Why can’t they keep these things simple?!

P/E ratio

This is a fairly complicated one but on a simple level it is just an alternative way of valuing a company. Standing for the “price-to-earnings” ratio, it is the stock’s latest closing price divided by the earnings per share for the previous year. This is supposed to give investors an idea of whether a stock is over or undervalued. A high P/E ratio could be a signal that the stock is overvalued, but it is not an exact science.

Diversification

When investing it is a good idea to diversify. This lessens your risk of your investments falling in value, as mentioned earlier. Diversification simply means splitting your investments across a number of different stocks or funds. Funds themselves have a certain amount of built in diversification as they are made up of a number of different company stocks. Diversifying means that if one of your holdings went bust and the value fell to zero, the blow on your portfolio would be softened. You should never have all of your investments held in a single stock to protect from this risk. The old adage holds true, don’t put all your eggs in one basket!

 

But what should I pay attention to?

As a starter investor you don’t need to pay too much attention to every number and graph on the screen.

performance

A stock’s performance will be important, however, conversely a rapidly-growing company may be one to avoid. This is particularly true if the firm is yet to actually turn a profit. Many companies grow rapidly because of hype around a new technology or theme before crashing spectacularly. Look instead for steady growth over a long time period.

dividend yield

Dividend yield is also likely to be important as it gives an idea of how lucrative the stock will be for you in the short term as well as the long term. While growth in a stock price is undoubtedly positive for your portfolio, until you cash out these gains are unrealised and could be lost again if things go pear-shaped. Dividends are paid annually, so the dividend yield is a good thing to look out for.

p/e ratio

If you are a little more experienced, then the P/E ratio can be a really good tool to help you find the companies that other investors are unfairly annoying, or aren’t worth the hype.

do your own research

But remember, you shouldn’t pick stocks based on just data alone.

Make sure to do your research into outside factors that may affect a company’s future success.

There are numerous guides on this website and others to help you make the right choices.

And remember to diversify your portfolio!

This is not financial or investment advice. Remember to do your own research and speak to a professional advisor before parting with any money.