Definitions of 5 stock market terms you’ll want to know
By Jack Fehr for Next Avenue
As the stock market continues its gyrations, now is a good time to buy an investment with a favorable NAV and alpha that keeps on giving while reducing beta.
If not, don’t be embarrassed. Investment companies and financial advisers love to load up their materials with this kind of jargon. Too bad they don’t just say something like this (a plain-English translation of the first sentence in this article): “You might want to buy an investment that is likely to grow faster and experience less risk than alternatives.”
Well, some actually do, but many still don’t. If companies aren’t willing to talk to you in a language you understand, it’s up to you to decipher their financial-speak.
So, here are five of the more widely-used, but not widely-understood, financial terms you should know:
Alpha It’s a measure of investment performance adjusted for risk. Think of alpha as the two extra chocolates you happily found in your bag of candy. Alpha is like an overfilled box of chocolates, the part of your investment return that is more than a benchmark market index.
For example, your large-company mutual fund may return 10 cents a share more than the Standard & Poor’s 500 Index — the benchmark to which you might compare the fund. Consequently, your alpha is 10 cents a share.
If your mutual fund has an alpha of 0, that means its performance has matched its benchmark (before fees are taken out).
Alpha is often used along with…
Beta This is a measurement of investment volatility or risk compared to the market overall. For example, when your investment’s beta is 2, that means its volatility, or risk, is twice as great as the volatility of the entire market. Tech stocks often have a beta of more than 1.
A beta of 1 means your investment’s price will move as much as the market and a beta of less than 1 (such as what you’d find with many utility stocks) means your investment isn’t as volatile as the market as a whole.
If you’re near retirement, keeping many investments with high beta probably isn’t wise, because you’re taking on extra risk. But if you’re younger and have time to weather market volatility, a little beta can be a good thing since it usually accompanies greater potential returns.
Bottom-up analysis When stock analysts look at specific companies with little regard to the overall economy or a broad industry, they practice the discipline known as doing a bottom-up analysis. They’re looking at firms based on their “fundamentals” — things like their financial statements, their management and how their products or services are doing.
It’s like looking for a grain of sand in the desert. For example, you might like to own Exxon-Mobil, no matter how the energy sector performs.
It’s the opposite of…
Top-down analysis Some investment analysts, by contrast, use top-down analysis to identify hot or cold industries and economic trends. They might think a sector that’s currently cold could depress even the best stocks in it.
Using top-down analysis might lead you to, say, shun all energy stocks at a given time. In other words, you’re avoiding the desert altogether.
NAV (Net Asset Value) Mutual fund managers and Exchange-Traded Fund (ETF) managers toss NAV around like it’s as familiar to you as your name. For many people, it’s not. But it is the figure calculated every day by funds and ETFs and the one that appears in financial listings and places like Morningstar.com that track these types of investments.
Net asset value is a mutual fund’s price per share or an ETF’s per-share value. You get it by dividing the value of all the stocks in the fund or ETF minus liabilities by the number of shares it has.
Here’s an example of how you’d find a fund’s NAV if it had $101 million in assets, $1 million in liabilities and 10 million shares: Subtract the $1 million in liabilities from the $101 million in assets to come up with $100 million. Then, divide that $100 million by the 10 million shares and you have a NAV of $10 per share.
You’ll get more shares in a fund with a NAV of $10 than in a similar fund with a NAV of $11. Simple math.
To complicate matters, shares of some mutual funds known as closed-end funds and ETFs can trade above or below their NAV.