Related terms to Equity finance

It comes in handy for the investor to understand these frequently used terms in equity finance.

Earnings Per share (EPS) – This is an indicator of the profits reaped by the company. It is the measure of the company’s profit that is allocated to each share among the common stock. It is calculated as the difference of net income and dividends on preferred stock divided by the average of the outstanding shares.

Price to earnings ratio (P/E Ratio) - This compares the actual price of a company’s share to its earnings per share. The P/E ratio is not a measure of the progress of a company. But a higher P/E ratio indicates more profit for the investors. To measure the progress of a company the P/E ratio of many companies of the same sector has to be compared.
Tequila Effect - This is based on the 1994 Mexican economic crisis in which the sudden drop on the value of the Mexican peso resulted in the chain reaction which led to the devaluation of other currencies in the South American region. This is also referred to as the Mexican Shock.
Return on equity (ROE) - This value is expressed as a percentage and is the return of net income as a percentage of shareholder’s equity. The ROE determines the profitability of the company and the amount of progress achieve by the money invested by the shareholders.

Return on Investment (ROI) – This measures the efficiency of an investment. It can also be used to compare efficiencies of different investments. The value is calculated by dividing the difference between the gain from the investment and the cost of the investment. It can be expressed as a percentage or even as a ratio.

Debt / Equity Ratio - This is the ratio of the total liabilities of the company to the equity of the shareholders. It is indicates exactly the proportion of equity that the company is utilizing for its assets. This is known as Personal Debt/Equity Ratio and can be applied to personal finances too.
Weighted Average Cost of Capital (WACC) - This calculation involves the exact proportion of capital that has been invested and calculates the firm’s total cost of capital. The various capital sources like common stock, preferred stock, bonds, long term debt etc are all included in the WACC calculations.
Ponzi scheme - This is named after Charles Ponzi, who orchestrated this fraudulent scheme where in high rates of returns are promised with very little risk to investors. The idea being that new investors are procured to generate returns for the older investors. This scheme functions fine as long as there is a supply of new investors.

Working Capital - This is the actual measure of the efficiency of a company as well as its financial reliability. This is difference of the current assets of the company and its current liabilities. A positive value indicates that the company is financially viable and a negative value indicates financial difficulties.

Derivative - These are securities that are valued according to the price of the underlying assets like stocks, bonds, currencies, market indexes, interest rates etc. It is just a contract between parties.