The Stock Market – Let’s get rich! (Part 4)

Hello again, investors!

Thank you so much to all our readers who have been following the series thus far. 

I’ve been using everyday analogies and simple logic to show you why the stock market is nothing to be intimidated by. 

Today, I’ll break down a few of the jargon and ratios. Remember that jargons are just a fancy way of saying something simple! Like Ballotine is boiled sausage, and an Aglet is a plastic shoelace!

INITIAL PUBLIC OFFERING (IPO)

This refers to the first time that a privately-owned company will offer shares to the public (you and me!). If what we buy into is the future value of a company, then, all things being equal, this is an opportune time to acquire shares in the company (reference NCB and Fontana examples in Part One).

PREFERENCE SHARES

As the word preference suggests, there are certain ‘preferred’ privileges that come along with holding preference share. The shares usually pay a fixed amount to investors periodically – most of which pay quarterly. There are several preference shares listed in both USD and JAD currencies on Jamaica’s stock exchange for e.g. JPS, Eppley, JMMB and Equityline Mortgage Company.  These shares are not so much for growth as there is rarely any movement in price. Investors would buy into these shares mainly for income. 

ORDINARY SHARES

Most of the ‘buzz’ around the stock market is centred around ordinary shares. Ordinary shares are also called common shares. These shares are purchased for growth opportunities (i.e. upward movement in price).

DIVIDEND

This is a sum of money paid to shareholders out of a company’s profits. With preference shares, these tend to be regular. For example, Equityline (listed in USD) pays an annual amount of 8 per cent, and payments are made on a monthly basis. Some companies will pay regular dividends to ordinary shareholders… consider it bonus money! These dividend payments are solely at the discretion of the company. Some companies that pay regular and attractive dividends on ordinary shares are Carreras, NCB and BNS.

‘BOOK VALUE’ and ‘PRICE to BOOK RATIO’ (P/B)

If a company sold all its assets and pays off all its debts, then what it’s left with is its book value.  The book value is what would be left to pay holders of ordinary shares if the company goes bankrupt.

P/B is a simple calculation where the company’s current share price is divided by its book value. If that works out to be 0.1 then it means that the share price is equal to the book value. If less, then the company is undervalued. If more, then the company is overvalued. Investors will buy companies whose P/B is 0.3 (share value is three times its book value) or even more because they believe the company’s book value will increase considerably in the future. Likewise, a company could be undervalued because investors believe the company does not have great future value.

PRICE to EARNINGS RATIO (P/E)

The P/E is what an investor is willing to pay for every $1.00 of profit that the company makes. So, if the company says that for every share it earns $1.00 but the stock is listed at $10.00 per share, the P/E would be 10 (i.e 10 ÷1). A high P/E ratio indicates that investors expect higher earnings. However, a stock with a high P/E ratio is not necessarily a better investment than one with a lower P/E ratio, it could indicate that the stock is being overvalued. On the flip, a stock with a lower P/E could mean the company is in a permanent state of decline.  

Most financial sites will figure both the P/B and P/E for you. Whereas P/B and P/E are important, they don’t stand alone. Remember that…

“Time is the friend of the wonderful company, the enemy of the mediocre.”

— Warren Buffet

Whew! That was a tad heavy, so read over twice. The keyword here is ‘future’!!!  Remember that the stock market is a forward-thinking tool.  Trust your instincts…. buy what you value and be patient!

We’ll be back to our regular selves next week! See you then!

— Monique Wilson holds a Masters in Business Administration from The Edinburgh University and has over twelve years of experience in the financial market.