September 8, 2006 11:25 am

Investment jargon

Every industry loves its jargon, as a convenient form of shorthand for insiders and to bedazzle outsiders. The investment community is no different, though given that much of its communication is with the smaller investor, it might be expected to be a bit more transparent in its dealings with the outside world.

The origins of much of the jargon are in the esoteric – for most people – worlds of mathematics, economics and investment theory. Throw in chunks of Greek and Latin and a few incomprehensible acronyms and it is small wonder that many investors are bemused.

■Alpha and beta

Alpha is what analysts look for in a share: its ability to outperform the average market return, which is known as beta. Technically speaking, alpha measures an investment’s risk-adjusted performance taking into account the market risk.

■Bottom-up/top-down

No Greek needed for these. A bottom-up approach to investing involves selecting individual stocks for their specific appeal regardless of any broader criteria. Top-down investing starts from an assessment of the outlook for a geographical area or industry sector.

■Underweight and overweight

An investment manager is underweight in a particular stock or sector if the holding makes up a smaller share of their portfolio than it does in a specified benchmark index, say, the FTSE All Share. Overweight is the reverse case.

■Long/short

To be “long” in an asset class means you will have some exposure to that asset, meaning you will profit if its price rises. To be “short” means you have exposure to that asset, perhaps through some of its derivatives, meaning you will profit if its price falls in value.

■Value and growth stocks

Value investing involves buying stocks that look cheap by measures such as their price/earnings ratio or their dividend yield. Often it is applied to shares that are priced at below the underlying net asset value. Growth investors concentrate on a company’s longer-term growth prospects with less emphasis on price. They are looking for rises in dividends and profits in the years ahead which should in turn lead to a rising share price.

■Correlation

The extent to which the prices of different asset classes such as shares, gilts and property move in line with each other. In general, fund managers build diversified portfolios to reduce the degree of correlation and cushion themselves against sharp falls in any particular market. Hedge funds and property, for example, have a low degree of correlation with shares although investing in property through quoted property companies increases the correlation. Correlation is normally measured on a scale from zero to 1.

■Liquidity

In the investing context, this refers to the ease at which you can buy and sell a particular asset, say a share in a company. If a company has a large number of shares or other securities in issue, this is likely to mean that there will be more marketmakers and a wider range of investors; hence it should be easier to buy and sell shares in large quantities. The more liquid a particular share, the easier it is to buy or sell a stake without moving the market price against you.

■Volatility

The degree to which the price of a share, market index or asset fluctuates. High volatility involves frequent and often sharp movements in a price. Infrequent investors often do not like volatility because they fear a price will be low when they come to sell. But active traders like it, taking the view it creates more opportunities to take a profit.

■Tracking error

The difference between the performance of, say, a share price and its benchmark market index. It is normally measured in percentage point terms.

■Outperform/underperform

A price that rises or falls more steeply than the market generally. Market performance is in line with the broader market.

■Bid/offer spread

The difference between the price you will be quoted depending on whether you are a buyer or a seller. This gives the marketmaker his margin. Spreads widen when there is not much liquidity and narrow when there is plenty of stock around. Where spreads are wide, this is often because the marketmaker is trying to compensate for the risk that he may not be able to find stock or sell it.

Price/earnings ratio

One of the commonest measures of how expensive or cheap a stock is. It is calculated by dividing the share price by the earnings per share. If the sums are done on the basis of the last set of company results it is known as the historic p/e; if it is based on an earnings forecast it is prospective.

It allows a comparison of different stocks or a comparison of a particular stock with the market. A high p/e generally reflects a positive view of a company’s prospects. Simply put, it tells you the number of years you would have to hold the stock for the company to achieve earnings that matched what you had paid for it. So if a company’s shares are trading on a p/e of 10, at the current rate of earnings, it would take 10 years for the cumulative earnings per share to equal the share price you paid.

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