The 65 terms that come up again and again in any stock analysis, each explained in a few sentences, with a formula where there is one and with the mistake it tends to cause.
Discounted cash flow (DCF) is a valuation method that works out what a company is worth today from the money it is expected to generate in the future. Each future cash flow is divided by a discount factor reflecting risk and the passage of time, and the sum of them all is the value of the business. Its strength is that it forces every assumption into the open; its limit is that the result depends entirely on them.
A three-stage DCF is a discounted cash flow that splits the future into three stretches with different growth rates: a few years of explicit projection, a transition phase in which growth fades gradually, and a final phase of stable growth in perpetuity. It avoids the common error of projecting today's growth forever, which is what most inflates the valuation of fast-growing companies.
WACC is the average cost of financing a company, weighing what it pays on its debt and what its shareholders demand according to the share of each. In a DCF valuation it is the rate at which future cash flows are discounted: the higher the WACC, the lower the present value of the business. A one-point change in WACC can move a valuation by more than 15%.
CAPM is the model that estimates the return a shareholder should demand from a stock. It starts from the return on a risk-free asset, usually the sovereign bond, and adds a premium proportional to that stock's market risk, measured by its beta. It is the standard way of working out the cost of equity that then feeds into the WACC.
Beta measures how much a stock moves relative to the market as a whole. A beta of 1 means the stock tends to move in line with the index; above 1 it amplifies both rises and falls; below 1 it dampens them. It is the parameter that translates market risk in the CAPM, and it is computed from historical data, so it describes the past rather than promising the future.
Terminal value is the part of a DCF valuation that captures everything the company will generate beyond the last projected year. It is usually computed assuming constant, modest growth in perpetuity, never above the growth of the economy itself. In practice it often accounts for more than half of total value, so its assumptions deserve the same scrutiny as the year-by-year projections.
The mid-year convention is a technical DCF adjustment that assumes cash flows arrive spread across the year rather than all at once on 31 December. Discounting them from the middle of the year instead of the end corrects a bias that would otherwise undervalue the company systematically. The effect is small but consistent, which is why it is standard practice in professional valuation.
The margin of safety is the gap between the value a valuation assigns to a company and the price it trades at. Buying with a margin of safety means paying below the estimated value, so that an error in the assumptions does not automatically turn into a loss. It is the explicit acknowledgement that every valuation is an estimate, not a measurement.
Earnings per share (EPS) is a company's net profit divided by the number of shares outstanding. It comes in two forms: basic, which uses today's share count, and diluted, which also counts the shares that could come into existence through options, convertibles or compensation plans. Diluted is the one worth looking at, because it reflects what each share would be entitled to if everything outstanding were exercised.
Price to book (P/B) compares a company's market capitalisation with its shareholders' equity: what would be left if it sold every asset and paid every debt at the value carried in the accounts. A P/B below 1 means the market is paying less than the books say. It is useful in banking and insurance, where the balance sheet genuinely reflects the business, and misleading for companies whose value sits in brands, software or people, which barely appear as assets.
PEG divides a company's P/E by its expected earnings growth rate. It comes from a reasonable intuition: a high P/E is justified if earnings are growing fast, and a low one can be a trap if the business is shrinking. Its weakness is that the denominator is an estimate, so PEG inherits whatever optimism or error sits in the growth forecast.
The equity risk premium is the extra return an investor demands for buying shares instead of an asset considered risk-free, usually government debt. It is the piece of CAPM that turns risk into a required-return figure, so it feeds into WACC and ends up moving any discounted cash flow valuation. It cannot be observed directly: it is estimated, and two reasonable estimates can differ by more than a percentage point.
Compound interest is interest calculated on the starting capital plus the interest already accumulated: each period starts from the larger capital the previous one left, which is why growth accelerates over time. It is the mechanism behind any long-term investment, dividend reinvestment and the terminal value of a DCF.
The IRR is the discount rate at which the present value of all cash flows of an investment, outflows and inflows, equals zero. It is the annual return implied by a project, a bond bought at a given price or an investment with irregular cash flows, and it is compared with the cost of capital to decide whether it creates value.
The Graham number is a rough maximum price per share: the square root of 22.5 times earnings per share times book value per share. It comes from the limits Benjamin Graham set for a defensive investor (a P/E no higher than 15 and a price-to-book no higher than 1.5, whose product is 22.5). It is a quick screen, not a valuation.
Graham number = √(22.5 × EPS × book value per share)
The Altman Z-score combines five balance-sheet and income-statement ratios into one number that ranks the risk of a company going bankrupt within the next two years. Below 1.81 signals the distress zone; above 2.99, the safe zone; in between, the grey zone. It was designed in 1968 for listed manufacturers and there are variants for other sectors.
Free cash flow (FCF) is the money left over after a company pays its operating expenses and the investment needed to keep the business running. It is the cash actually available to repay debt, pay dividends or buy back shares, and it is the figure discounted in a DCF. Unlike accounting profit, it is hard to dress up.
EBITDA is a company's profit before interest, taxes, depreciation and amortisation. It helps compare the operating profitability of companies with different financing or tax structures, but it deliberately ignores the cost of replacing assets, so it is not the same as cash generated. In capital-intensive businesses the gap between EBITDA and free cash flow is enormous.
Enterprise value (EV) is what it would cost to buy a company outright: its market capitalisation plus the debt taken on, minus the cash it already holds. Unlike market cap, EV does not depend on how the company is financed, which makes it possible to compare two firms in the same sector even if one carries heavy debt and the other none.
EV/EBITDA shows how many times annual operating profit you pay to buy the whole company. It is the preferred multiple for comparing companies with very different debt levels, because both numerator and denominator sit before the effects of financing. It only means something against peers in the same sector: what is expensive in retail is cheap in software.
The P/E ratio shows how many times annual earnings per share the market is paying for a stock. A P/E of 20 means you pay 20 years of current earnings. It is useful for comparing companies in the same sector and against their own history, but it stops meaning anything when the company is loss-making, and a low P/E usually signals a problem rather than a bargain.
ROE measures how much profit a company generates for every euro put in by its shareholders. A high, sustained ROE points to a business that reinvests successfully, but it should be read alongside leverage: debt can inflate ROE without improving the underlying business at all, because it shrinks the equity sitting in the denominator.
ROIC measures the return a company earns on all the capital it employs, whether it comes from shareholders or lenders. Set against the WACC, it answers the decisive question of whether the company creates or destroys value: it only creates value when ROIC sustainably exceeds its cost of capital. For many investors it is the single best indicator of business quality.
Operating margin is the percentage of sales left as profit after operating costs, before interest and taxes. It measures the efficiency of the business itself, and its trend over the years says more about a company's health than its absolute level in any single year: a margin that narrows year after year is a warning sign even while it stays high.
Net debt is a company's total financial debt minus its cash and equivalents. It reflects real leverage: a company with a lot of debt but also a lot of cash is less leveraged than it looks. It is usually read divided by EBITDA, to gauge how many years of operating profit it would take to clear it; above three times, room for manoeuvre narrows.
Dividend yield is the annual dividend a share pays divided by its price. It expresses the cash return a shareholder receives at the current price. An unusually high yield is usually the result of a falling price rather than a rising dividend, and deserves checking before it is read as a good sign.
The payout ratio is the percentage of profit a company distributes as dividends. A low payout leaves room to reinvest and to sustain the dividend through bad years; one close to or above 100% means the company is paying out everything it earns, or more, leaving the dividend exposed to any drop in results.
ROCE measures the operating profit a company earns per euro of capital employed, meaning shareholders' equity plus financial debt. It answers whether the business generates more than the money it uses costs: a ROCE sustained above WACC is the practical definition of creating value. It resembles ROIC, differing mainly in that it works before tax and in how it treats cash.
ROCE = operating profit ÷ (shareholders’ equity + financial debt)
Net debt to EBITDA shows how many years of operating profit before depreciation it would take to clear net financial debt. It is the most direct way to size borrowing against the ability to generate cash, and the benchmark banks write into loan covenants. Above 3 tends to raise flags, though the tolerable threshold depends heavily on the sector: a regulated utility lives comfortably with levels that would suffocate a cyclical business.
Capex is the money a company invests in long-lived assets: factories, machinery, stores, servers. It splits into maintenance capex, needed to keep the business running as it is, and expansion capex, meant to grow it. The distinction matters because only the first is deducted to reach free cash flow in the strict sense, and because a company that cuts capex can flatter its cash for a few years at the expense of its future.
Operating cash flow is the cash that comes in and goes out through a company's ordinary activity, before investment and financing operations. It starts from accounting profit and adds back the entries that move no money, such as depreciation, while adjusting for working capital. Comparing profit against operating cash flow over several years is one of the most useful checks there is: if profit grows and operating cash does not follow, something is being recognised before it is collected.
Working capital is the difference between current assets and current liabilities: what a company will collect or turn into cash within the year, minus what it must pay over the same period. It measures the cushion it has for its short-term commitments. Negative working capital is not always a bad sign: supermarkets collect on the spot and pay suppliers at ninety days, financing the business on precisely that gap.
Working capital = current assets − current liabilities
Gross margin is what remains of each euro of sales after subtracting the direct cost of producing or buying what was sold; net margin is what is left at the end, once every expense, interest charge and tax has been deducted. The gap between them reveals a business's cost structure: a high gross margin that turns into a thin net margin gives away a company carrying heavy overheads, heavy debt, or both.
Gross margin = (revenue − cost of sales) ÷ revenue
TTM is the sum of the last four reported quarters, rather than the last closed financial year. It gives an up-to-date annual figure without waiting for the accounting close, and is the usual basis for ratios such as P/E when they are meant to reflect the recent picture. It is worth checking that the four quarters are picked by date rather than by simple count: when a company restates or delays a quarter, counting backwards without looking at the calendar produces a year of twelve or fifteen months.
Reported earnings are what comes out of applying the accounting standard: US GAAP in the United States, IFRS in Europe. Adjusted earnings are what the company itself publishes after excluding items it considers exceptional: restructuring, impairments, share-based compensation. The gap can be large and is not standardised, so every company adjusts in its own way. Hence the rule most often broken when reading results: if the analyst consensus is on an adjusted basis, comparing reported earnings against it does not measure a surprise, it measures a difference in accounting criteria.
An earnings surprise is the difference between what a company reports and what the analyst consensus expected. Beating the estimate is called a beat; falling short, a miss. It explains much of the sharp movement on reporting day, because the price already embedded the forecast and only reacts to what was not priced in. An honest surprise requires comparing like with like, and looking at revenue as well as profit: beating on earnings by cutting costs while sales disappoint tells a very different story.
A capital increase is the issue of new shares by a company to raise money. When it comes with pre-emptive rights, every shareholder receives rights in proportion to their stake and can take them up, sell them or let them lapse. The issue price is usually below the market price, which is why the quote adjusts by averaging old and new shares.
Treasury shares are a company’s own shares that the company has bought back and holds on its balance sheet. While held in treasury they neither vote nor collect dividends, and if they are cancelled they disappear, so profit is spread over fewer shares and earnings per share rise even though total profit does not change. Buybacks are the way of returning cash to shareholders that does not go through the dividend.
EPS after cancellation = net income ÷ (shares − cancelled)
A scrip dividend is a dividend the company pays in new shares instead of cash, usually offering a choice: receive shares, sell the right back to the company at a set price, or sell it on the market. For the company it is a way of paying shareholders without cash leaving the business, except what it pays those who choose cash. Since the new shares split the same company into more pieces, whoever takes cash ends up with a slightly smaller stake, offset by the cash received, and whoever takes shares keeps theirs or raises it slightly.
New shares = shares held ÷ shares required per new share
Volatility measures how sharply an asset's price swings around its trend, and is usually expressed as the annualised standard deviation of its returns. It is the most widely used risk measure, though it has a known flaw: it treats sharp rises exactly like falls, and only the latter keep investors awake.
VaR estimates the maximum loss a portfolio should not exceed over a given horizon at a given confidence level. A 5% one-day VaR of 3% means that on 95 days out of 100 the daily loss would stay below 3%. Its limitation is obvious and famous: it says nothing whatsoever about how much can be lost on the other five days.
CVaR, also known as expected shortfall, answers exactly what VaR leaves out: the average loss across the worst scenarios, those beyond the VaR threshold. That makes it a better description of tail risk and generally the more prudent measure. If VaR tells you where the bad day starts, CVaR tells you how bad it is on average.
Maximum drawdown is the largest cumulative fall from a peak to the subsequent trough over a period. It measures the worst blow suffered by someone who bought at exactly the wrong moment, and it is the figure that best predicts whether an investor can stick with a strategy: a portfolio with a 50% drawdown needs a 100% rise just to get back to where it started.
A Monte Carlo simulation generates thousands of possible paths for a portfolio, each with random returns consistent with its historical volatility and correlations. Instead of a single answer it returns a distribution of outcomes with their probabilities, which lets you talk about scenarios rather than predictions. It is only as good as the assumptions feeding it.
Correlation measures, between −1 and +1, how far two assets move together. Near +1 they rise and fall in step; near −1 they offset each other; near 0 they are independent. It is the basis of diversification, with one important caveat: in a crisis correlations tend to shoot towards 1, precisely when you most needed them not to.
The Sharpe ratio divides the return earned above the risk-free asset by the volatility taken on to get it. It answers how much was gained per unit of risk borne, and allows comparison between strategies that would make no sense judged on raw return alone: making 20% through constant lurches is not the same as making 12% without them.
The efficient frontier is the set of portfolios offering the highest expected return for each level of risk. Any portfolio below that frontier can be improved: there is another combination of the same assets that returns more without taking on more risk, or takes less risk for the same return. It is the central idea of modern portfolio theory.
Alpha is the part of a portfolio's return that its exposure to the market does not explain. If beta says how much a portfolio should have risen given what the index did, alpha is how much it rose above or below that expectation. It is the standard measure of whether active management adds anything, and also the easiest to confuse with luck: over short periods, positive alpha is rarely distinguishable from chance.
The Sortino ratio measures return per unit of risk, like the Sharpe ratio, but counting only downside volatility in the denominator. It starts from a sensible objection to Sharpe: penalising sharp gains as if they were risk does not match what actually worries an investor. It usually produces higher figures than Sharpe for the same portfolio, so comparing the two means nothing; only Sortino against Sortino makes sense.
CAGR is the constant rate at which a figure would have to grow each year to move from its starting value to its ending value over the measured period. It turns an irregular path into a single comparable annual number, which is why it is the correct way to summarise a multi-year return: adding each year's percentage and dividing by the number of years is systematically wrong. What it hides is the path, and the path matters: two series with the same CAGR can have suffered very different drawdowns along the way.
Market capitalisation is the market value of all a company's shares: the share price multiplied by the number of shares outstanding. It is the standard measure of a company's size and determines whether it counts as large, mid or small cap, which in turn shapes its liquidity and its presence in indices.
Free float is the portion of a company's capital that trades freely on the market, excluding control stakes that are never sold. A small free float means less liquidity and sharper price moves in response to modest orders, something worth bearing in mind before taking a large position in a small company.
A screener is a filter that runs across a broad universe of securities and returns only those meeting the criteria you set, such as a P/E range, a minimum ROIC or a particular sector. It takes you from thousands of possibilities to a shortlist worth researching properly. It is a tool for ruling things out, not for deciding.
Backtesting means running a strategy over historical data to see how it would have performed. It is useful for discarding ideas that never worked, but a good past result guarantees nothing: the main risk is fitting the strategy so tightly to history that it stops working outside it. Backtest results are simulated, never actual returns.
Insider transactions are the purchases and sales of shares made by executives and board members in their own company, which must be disclosed publicly to the regulator. Purchases tend to read as a sign of confidence, since nobody knows the business better; sales admit many explanations unrelated to it, from taxes to personal liquidity, and so tell you far less.
Analyst consensus is the average of the estimates and recommendations published by the research houses covering a stock, usually on future earnings and a price target. It is a reference point for market expectations, not a reliable forecast: its usefulness lies more in the reaction when results miss it than in how often it is right.
An ETF is an investment fund that trades on an exchange like a share, so it can be bought and sold throughout the session at the market price. Most track an index, which allows an entire basket of holdings to be bought in a single trade and at fees far below active management. What matters before choosing one is not its name but exactly what it tracks, how it tracks it, what ongoing charges it levies, and how far it drifts in practice from the index it follows.
The TER is the annual percentage a fund or ETF deducts from assets to cover management, custody and administration. It is not billed separately: it is subtracted day by day from the net asset value, so published returns already have it taken out. It looks small and is not: over long horizons, the difference between 0.20% and 1.20% a year eats a very substantial share of the final outcome, through the same compounding that grows the investment.
The ex-dividend date is the day from which buying a share no longer carries the right to the next dividend. To collect it you must hold the share before that date; anyone buying on it or later does not receive it. At the open of the ex-dividend session the price typically opens marked down by roughly the amount distributed, which explains falls that look abrupt on a chart and answer to no news at all. This is why adjusted historical series correct that jump: without the adjustment, any long-run return calculation comes out wrong.
A stock split divides each share into several, multiplying the number of shares and reducing the price in the same proportion. A reverse split does the opposite: it consolidates several shares into one and raises the price. Neither changes the value of the holding or of the company. They matter for what they break: any historical series or per-share figure not adjusted for splits produces meaningless comparisons, and an EPS from ten years ago left uncorrected can be wrong by a factor of four.
A basis point is one hundredth of a percentage point, that is, 0.01%. It is used for interest rates, bond yields and fees to avoid the ambiguity of percentages: saying a rate rises 2% could mean it goes from 4% to 6% or from 4% to 4.08%, whereas saying it rises 200 basis points admits only one reading. A typical central bank move is 25 basis points.
A volume profile distributes traded volume across price levels rather than across time, showing the prices at which stock actually changed hands. The level with the most accumulated volume is called the POC, or point of control, read as the price where buyers and sellers found most agreement. Thin-volume zones tend to be crossed quickly and heavy ones tend to slow price down. It is a descriptive reading of the past, not a forecast.
Pre-market and after-hours are the trading windows before and after the regular session. They exist because much of the news that moves a company, starting with its results, is published outside regular hours. They carry far less volume than the session, so spreads widen and a spectacular move can rest on very few trades. An 8% jump after hours is not a reliable guide to where the stock will open the next day.
A security's liquidity is how easily it can be bought or sold without moving its price. It shows up in traded volume and above all in the spread, the gap between the best bid and the best offer at any moment. It is an invisible cost that appears in no commission line: in a thin stock, getting in and out can cost several tenths of a percent before the price has moved a cent. And it is a risk as well as a cost, because liquidity tends to vanish exactly when it is most needed, in falling markets.
A tender offer is a public offer addressed to all shareholders of a listed company to buy their shares at a set price, in cash, in shares or in a mix. It can be voluntary or mandatory (in Spain, on crossing 30% of the voting rights or appointing a majority of the board), friendly or hostile, and it carries a premium over the previous quote because otherwise nobody would accept. The regulator approves the prospectus and oversees the process.
This glossary is for educational purposes and does not constitute financial advice or an investment recommendation. The definitions describe concepts in general use in financial analysis; how they apply to a specific decision depends on your circumstances. Read the financial disclaimer.