Category: Glossary


Advantages of Small Caps

Filed Under: Glossary by Bill — Comments Off
June 14, 2010

Small cap stocks are companies that have a market cap of less than $2 billion.  The market capitalization is calculated by taking the number of outstanding shares and multiplying by the current share price.

There are some great advantages to small cap stocks.  First of all, these cap sized stocks have room to grow.  If a company is gigantic, they can only grow so much more.  With small stocks, you have a lot more potential that it will grow and may even grow fast.

Secondly, many large institutional investors ignore small cap stocks.  The reason is because in order for a large investor to go to the trouble to buy these stocks, they have to buy a very large percentage of the ownership of the company.  In many cases, it means buying a controlling share in the company.  In order for them to do this, they must get approval from financial regulators.

Once these institutional investors file their regulatory applications, other players in the market see what’s happening.  While the paperwork is being process, other smaller investors and traders will come and buy the stock and drive up the price.  So there is very little benefit for a large investing firm to buy small caps.  Because of this, you don’t have these big guys as competitors and that is surely an added benefit.

The other great thing about small cap stocks is that you can afford to buy more of them.  That means you can diversify more and you should.  These stocks tend to be a lot more risky and volatile.  Many don’t make it big.

In order to offset the failure of a few, you should invest in enough of them to ensure that you have a good chance of at least a few of these to get big.  You can let someone else do this for you buy investing in small cap mutual funds that hold these cap sized stocks in their basket.  By doing this, you are diversifying without having to do your own stock picking which can get tedious with this category of stocks.

There are differences in investing in large cap vs small cap funds. There are different risk and rewards associated with it.  Each investor should decide after much research and getting advice from their investment advisor.

Tags: , , ,
Permalink

A Quick Explanation Of Stock Options

Filed Under: Glossary by Bill — Comments Off
February 21, 2010

Most investors, when they have a hunch that the price of a given stock is going to move up or down, will buy or sell short the company’s shares in an effort to benefit from the move that they anticipate. Call or put options allow investors to use leverage and attempt to make a greater percentage gain with a given amount of money than they would by simply buying or shorting shares. Options should be purchased by more sophisticated investors only, because being on the wrong end of a leveraged investment means that you leave yourself open to losing a greater percentage, or all, of the money you have in that position.

But you assume no risk in simply having stock options explained to you. An option is simply the right to buy (in the case of a call option) or sell (for a put option) 100 shares of stock at a given price, at a given date in the future. Here are a few critical things to understand:

You are buying the right to buy the shares, not the shares. The right has a value that will fluctuate between now and the so-called expiration date of the option, based on movements in the share price. You may buy and sell this right before options expiration; most people do not buy options to actually purchase the shares, but to make money from the fluctuations in the value of the option.

Stock options have a strike price that is the amount at which you may purchase the shares, if you hold to expiration. If, at options expiration, the price of the stock is below the strike price (i.e. out of the money) the option will expire worthless, because having the right to buy something at a price that is above the current market price has no value.

If, at options expiration, the price of the stock is above the strike price (i.e. in the money) the option will have an intrinsic value that is determined by how many points the stock price is above the strike price, times 100 (because each contract covers 100 shares of stock).

Maybe the hardest thing conceptually about understanding stock options is the concept of time value. In addition to the intrinsic value, which as we have seen will be zero if the stock price is below the strike price of the contract, the market will ascribe a value to our contract based on how much time is left until expiration, and the likelihood that the option will expire in the money (as determined by the “collective wisdom” of the market). This means that while an options contract may have zero intrinsic value, it can still have value because of the time value component, and the stock’s potential to move higher than the strike price before expiration.

Even the most seasoned investors use only a portion of their investment funds to trade options. The old adage is: buy options only with money that you can truly afford to lose. The good news about options is that you cannot lose more than you invest, but studies have shown that approximately 90% of long put and call options positions either expire worthless or are sold at a loss. That should be your real lesson from this stock options explanation: buyer beware: do your homework and don’t get greedy.

Tags:
Permalink

Dividend Yield Definition and Ex Dividend Definition

Filed Under: Glossary by Bill — Comments Off
January 26, 2010

We have to accept this fact that financial terms are not a part of our daily vocabulary, therefore learning their meaning is necessary before investing because paying the cost of misunderstanding  can be costly. This rule of thumb applies to all terms in finance, but this time we are going to talk about ex dividend definition and dividend yield definition.

A dividends yield is a percentage return from dividends income, which is based on share pricing. This yield is paid annually . When there are not capital gains, dividend yield is defined by return on stock investment, in both dividend yield definition and ex dividend definition, dividend yield helps investors to determine the amount of cash flow obtained for every dollar invested in an equity position.

In the past, investors used to look at dividends coming from their share holdings to secure cash flow by investing in stock paying higher dividends. Today they are more concerned about capital gains investing in stocks that pay higher. Therefore, dividend definition can be explained as the portion of a company’s earnings  which are paid to shareholders.

On the other hand, stocks ex dividend definition refers to the classification of trading shares belonging to a seller instead of the person acquiring such shares, but once the corporation has authorized the seller to receive such dividends.

Shareholders remain qualified to receive dividends, but difference between dividend yield definition and ex dividend definition strives on the date in which shares are sold for  dividends payment, either coming from registrars or the stock exchange, so makes no difference who is the new shareholder when it comes to receive a payment after sale, although once an ex date is declared, stock drops often in price proportionally to the total amount of dividends a seller may expect.

There are companies that offer dividend reinvestment plans and these  are for those who are looking for good passive income by dividends.

Tags: , ,
Permalink

Margin Call is Just Before Last Call

Filed Under: Glossary by Bill — Comments Off
January 25, 2010

Margin, investor’s siren song, is often hard to resist.  The temptation of leverage to see huge returns, portfolios rocketing into the millions, it is the fantasy.  So what keeps us from throwing caution to the wind, trusting our instincts and research, and leveraging to our eyeballs for big wins?  The margin call. 

When you buy stocks on margin you are borrowing money for a portion of the purchase.  Typically average investors can only borrow half of what they wish to purchase.  Crazy hedge funds can get away with borrowing much much more.

If your investments fall in value and the amount of your investments is worth an amount close enough to the amount you owe the brokerage may initiate a margin call.  In most instances they will sell enough stock, regardless of the price, to pay off your loans usually leaving you with nothing or near nothing.  Unless you are well established you have very little say in the manner.  Any firm you buy stocks on margin with should provide a margin call formula or margin call calculator so there is no misunderstanding on when your account will be in danger.

Having your stocks sold on a margin call has two devastating impacts to the investor.  One is the stocks are sold when the price is down.  This is usually the exact opposite of when you wanted to sell unless it saved you from a plummeting stocks.  The other negative impact is to the psychology of the investor.  They now feel defeated and will be less capable of pulling the trigger on the next good investment they come across.  Hesitation on a well defined plan leads to lost profits.

Margin needs to be used as part of a well developed plan and not a guarantee of massive gains.  If your losses aren’t minimized to smaller swings than your wins than high margin accounts will wipe you out.

Tags: , , ,
Permalink