Financial Terms

Here are some key financial terms that will help you understand when investing in businesses.

Declaration Date: The date on which the board of directors of a company announces the amount of the next dividend and its ex-dividend, record and payment dates.

Ex-Dividend Date: The date on which, or after, the stock trades without a dividend. So if you buy the stock on or after the ex-dividend date, you will not receive the next dividend. If you sell a stock before the ex-dividend date, you will not receive the dividend (the buyer will receive the dividend). If you sell after the ex-dividend date, you will receive the dividend (the buyer will not).

Record Date: The date the company determines the list of shareholders who qualify for the dividend. To be a shareholder of record, you must own the stock at least one day before the ex-dividend date.

Payment Date: The date on which the dividend is paid to shareholders of record, in the form of a dividend check, or a credit to your account.

Earnings per Share (EPS) is defined as net income divided by the number of shares of stock issued to stockholders. Higher EPS values indicate the company is earning more net income per share of stock outstanding. Because EPS is one of the five performance measures on which a company is graded and because a company should have a higher EPS target each year, you should monitor EPS regularly. 

There are two ways to boost EPS one is to pursue actions that will raise net income.

A second means is when the company boosts it's EPS by repurchasing shares of stock, which has the effect of reducing the number of shares in the possession of shareholders—net income divided by a smaller number of shares yields a bigger EPS.

Return on average equity (ROE) ROE is defined as net income divided by the average amount of shareholders’ equity investment—the average amount of shareholders’ equity investment is equal to the sum of shareholder equity at the beginning of the year and the end of the year divided by 2.

Total shareholder equity at the end of the year turns out to be larger than total shareholder equity at the beginning of the year whenever the company’s dividend payments are less than its net profits (such that some earnings are retained in the business—all retained earnings add to the amount of shareholders’ equity). Higher ROE values indicate the company is earning more after-tax profit per dollar of equity capital provided by shareholders. Because ROE is one of the five performance measures on which a company is graded  and because a company’s annual target should be at least 15%you should monitor the ROE regularly.

One way a  company can boost ROE is to pursue actions that will raise net income  A second means of boosting ROE is torepurchase shares of stock, which has the effect of reducing shareholders’ equity investment in the company, thus producing a higher ROE percentage.

Operating profit margin is defined as operating profit divided by net revenues (where net revenues represent the dollars received from sales). A higher operating profit margin is a sign of competitive strength and cost competitiveness. The bigger the percentage of operating profit to net revenues, the bigger the margin for covering interest payments and taxes and moving dollars to the bottom-line.

Net profit margin is defined as net profit (or net income or after-tax income, all of which mean the same thing) divided by net revenues, where net revenues represent the dollars received from sales. The bigger a company’s net profit margin (its ratio of net profit to net revenues), the better the company’s profitability in the sense that a bigger percentage of the dollars it collects from footwear sales flow to the bottom-line. A company’s net profit margin represents the percentage of revenues that end up on the bottom line

The debt-to-assets ratio is defined as all loans outstanding divided by total assets -both numbers are shown on the company’s balance sheet. All loans outstanding include (a) 1-year loans outstanding, (b) long-term bank loans outstanding, (c) the current portion of long-term loans that are due and payable, and (d) any overdraft loans that are due and payable—all these amounts are reported on the company’s balance sheet, as is the amount of total assets. A debt-to-assets ratio of .20 to .35 is considered “good”. As a rule of thumb, it will take a debt-to-assets ratio close to 0.10 to achieve an A+ credit rating and a debt-asset ratio of about 0.25 to achieve an A– credit rating. Debt-to-asset ratios above 0.50 (or 50%) are generally alarming to creditors and signal “too much” use of debt and creditor financing to operate the business.

The interest coverage ratio is defined as annual operating profit divided by annual interest payments. Operating profit is reported on the Income Statement along with interest payments.

The current ratio equals current assets divided by current liabilities. It measures the company’s ability to generate sufficient cash to pay its current liabilities as they become due. At the least, a company’s current ratio should be greater than 1.0; a current ratio in the 1.5 to 2.5 range provides a much healthier cushion for meeting current liabilities. Ratios in the 5.0 to 10.0 range are far better yet.

The dividend yield is defined as the dividend per share divided by the company's current stock price. It shows what return (in the form of a dividend) a shareholder will receive on their investment in the company if they purchase shares at the current stock price. A dividend yield below 2% is considered “low” unless a company is rewarding shareholders with nice gains in the company’s stock price price. A dividend yield greater than 5% is “considered “high” by real world standards and is attractive to investors looking for a stock that will generate sizable dividend income.

The dividend payout ratio is defined as total dividend payments divided by net profits (or the dividend per share divided by earnings per share—both calculations yield the same result). The dividend payout ratio thus represents the percentage of earnings after taxes paid out to shareholders in the form of dividends. Generally speaking, a company’s dividend payout ratio should be less than 75% of net profits(or EPS), unless the company has paid off most of its loans outstanding and has a comfortable amount of cash on hand to fund growth and contingencies.

Intrinsic Value is the discounted value of the cash that can be taken out of a business during its remaining life. The calculation of intrinsic value is not so simple, intrinsic value ia an estimate rather than a precise figure, additionally an estimate that must be changed if interest rates or future cash flows change.