Speaking the Language : Profit Margins and Price-to-Earnings Ratios: Phrases You Need to Know to Play the Market

Here’s a glossary of valuable financial words, phrases and terms that are likely to figure prominently in analysts’ reports and annual statements to shareholders, as well as in the financial pages of this newspaper.

* American depositary receipt: A receipt issued by a U.S. bank representing shares in a foreign company.

* Assets: The sum total of what the company owns in property, equipment, inventory and investments before accounting for any debt.

* Beta: Measure of a company’s stock price volatility relative to the market. A beta above 1.0 indicates that, on average, the stock rises or falls to a greater extent than the market; a beta below 1.0 indicates movement to a lesser extent than the market.

* Board of directors: A group of individuals who are elected by shareholders and charged with looking out after shareholder interests. Members of the board are consulted on matters of great import to the company, but generally are not given authority over day-to-day operations. Directors usually meet several times a year and are paid for their services. Some directors may also be members of the company’s management.

* Book value: Equity--the sum of the company’s assets minus debts--divided by the number of shares outstanding. In other words, if the company has $1 million in equity and has issued 500,000 common shares, its book value amounts to $2 per share.

* Cash flow: This is how much cash the company has coming in from day-to-day operations compared to the amount it pays out on its bills. Cash flow has little meaning unless preceded by another adjective. Strong cash flow would be good, indicating the company has more than enough money coming in to cover its debts. Negative cash flow, on the other hand, is another way of saying that the company is borrowing to pay its monthly bills. Left unabated, negative cash flow is frequently a precursor to one of the very unpleasant terms: Chapter 7 or Chapter 11.

* Chapter 7: A corporate liquidation--closing or selling all operations--under protection of U.S. bankruptcy laws. This means employees are likely to be laid off, suppliers may be left unpaid, and shareholders are likely to find their stock lost its value.

* Chapter 11: A corporate reorganization under protection of U.S. bankruptcy laws. This is better than a liquidating bankruptcy, because the company plans to stay in business, which means it must continue to make at least partial payments to both suppliers and employees. However, it still spells uncertainty--particularly for shareholders who get few guarantees in bankruptcy proceedings.

* Closely held: Refers to situations where all of a company’s common shares are owned by a small number of individuals. A closely held company’s shares typically are not available to the general public.

* Controlling shareholder(s): Instances where one or several shareholders vote in concert and consequently determine whether shareholder proposals win or lose--regardless of the wants of so-called minority shareholders. Gaining voting control usually requires owning more than 50% of the common stock. However, in companies where there are dual classes of stock, controlling shareholders can own less than 50% of the shares and have voting control. That’s because in dual-class voting arrangements, some shares get more votes than others.

* Debt-to-equity ratio: Long-term debt divided by total equity. This is a snapshot indicating whether or not the company is overextended. Companies that are growing rapidly can usually carry a higher level of debt than slower-growing firms--just as individuals who get large raises every year can afford more debt than those who don’t.

* Dividend: Payments to shareholders that typically come at regular intervals--usually once every three months. These payments can be made in either cash or stock.

* Dividend yield: The value of annual dividends paid to shareholders as a percentage of the company’s current market price. For example: Company X pays $1 in cash dividends each year and its shares sell for $30 each on the New York Stock Exchange. Its dividend yield would be 3.3% of its stock price.

* Dollar-cost-averaging: System of putting equal amounts of money into an investment at regular intervals to lessen the risk of investing a large amount at an inopportune time.

* Earnings estimate: Financial analysts estimate the earnings they believe the company will report next year and several years into the future by talking to the company’s management and analyzing the company’s financial reports. These estimates are used by brokers and analysts to determine if a company’s shares will be worth owning in the future.

* Earnings per share: This is the company’s total earnings divided by the number of shares it has outstanding. A company with $1 million in earnings and 250,000 shares would report earnings per share of $4.

* Equity: The value of what the company owns once debts are taken into account. It’s similar to equity in your home. If the home is worth $100,000, but you owe $50,000 on the mortgage, you have $50,000 in equity.

* Exchange: Also, stock exchange. Refers to the market where the company’s shares are sold. This can be an actual place--such as the American Stock Exchange (AMEX), the New York Stock Exchange (NYSE) or the Pacific Exchange (PE)--where traders shout their intention to buy or sell various company shares. Or it can be a computerized market system, such as the NASDAQ system, where shares are bought and sold by punching keys on a computer keyboard.

* Ex-dividend: Synonym for “without dividend.” The buyer of an ex-dividend stock is not entitled to the next dividend payment.

* Extraordinary dividend: A one-time payment to shareholders, made either in cash or stock.

* Extraordinary item: A one-time profit or loss, usually from the sale or liquidation of a subsidiary that didn’t pass muster.

* Golden parachute: Contractual severance agreements with executives that would give them large payments--often three to five times their annual salary--if they quit, were fired or demoted following a hostile takeover.

* Goodwill: A value given to intangible assets, such as trade names.

* Hostile takeover: A company buyout that is completed (or attempted) without the agreement of the target company’s management or board of directors.

* Income: Usually refers to a company’s net earnings, after tax. However, it can also be used to refer to pretax income and income before extraordinary items.

* Initial public offering: Also, IPO. The actual sale, for the first time, of a company’s shares to the public. The term also is used to refer to companies that “went public” within the past year.

* Institutional investor: Organization that trades a large volume of securities, such as a pension or mutual fund, insurance company or bank.

* Junk bond: Bond purchased for speculative purposes. Usually rated BB or lower, it has a higher default risk than higher-rated bonds.

* Limit order: An order to buy or sell a specified amount of a security at a specified price--or a better one--if available.

* Margin: The amount of funds put up by a customer who is simultaneously borrowing on credit from the broker to buy or sell a security.

* Market order: Order to buy or sell a stock at the best available price.

* Market value: The value of the company, based on the selling price of its cumulative shares on the open market. In other words, if the company had 2 million shares outstanding and its shares sold on the New York Stock Exchange for $4 each, its market value would be $8 million.

* Market value as a percentage of book: This ratio gives an indication of the company’s selling price compared to the value of its assets. It helps analysts determine whether the company’s stock is overpriced or a relative bargain. However, it can be deceiving in some instances where the value of certain assets--such as goodwill--is hard to quantify.

* Net current assets: Current assets minus current liabilities. Also known as working capital.

* Operating margin: The percentage of revenue remaining after paying all operating expenses.

* Option: A derivative security giving the holder the right to buy or sell a specified amount of the underlying security at a specified strike price within a specified time frame. The buyer hopes the stock price will go up if he or she buys a “call” or down if he or she buys a “put” by an amount sufficiently above or below the strike price to provide a profit when the option is exercised.

* Over-the-counter: The sale of a company’s shares through computerized trading, but not through a formal exchange, such as the AMEX or the NYSE.

* Poison pill: One of a variety of techniques that companies may use to discourage an unfriendly buyout. These techniques can involve selling prized corporate assets to a friendly third party to make the remaining company less attractive or creating new shares of stock that would make a corporate takeover more expensive.

* Price-to-earnings ratio: Comparison of the company’s per share market price with its current or estimated per share earnings. For example: Company Y’s shares sell for $10 each at a time when it earned $1 per share. Its P/E is 10, or $10 divided by $1.

* Privately held: A company that is owned by one or a handful of related individuals. The company’s shares are not available to the general public, nor sold on a public exchange.

* Profit margin: A ratio indicating how a company’s profits compare with its sales or revenues. Generally speaking, the higher the profit margin, the better.

* Public company: A company that offers its shares to the general public by listing them on an exchange or offering them for sale over-the-counter.

* Return on assets: A measure of profitability, usually used for banks and savings and loans, which is calculated by dividing annual net income by total average assets.

* Return on equity: A measure of profitability calculated by dividing annual net profits by total equity. This measurement can be deceiving, however, because the smaller the company’s equity, the more profitable it seems.

* Revenue: Net sales of goods, products or services.

* Symbol: Also stock symbol. A three- or four-letter code that is used by brokers to call up a company’s financial information and stock price and also is used in trading shares.