Dubai: The terms that you come across when watching financial news can often get confusing. The usage of words and the sheer amount of jargon that is used, makes it difficult to understand for the average reader. If you’ve never studied economics, you may well relate to this struggle.
However, as money plays a vital role whoever you are, what can you do to make understanding such articles or news easier? Understanding a few common terms related to the market and ability to decipher the meaning of words used in their related context can help you get started.
Illustration: See if you can understand the terms given in this short piece of financial news
“The equity benchmark XXX rallied for straight sessions and jumped 1234 points on positive global cues.”
“Tech major YYY missed its quarterly earnings target, but shares jumped as a result of analyst upgrades”
“The bullish/bearish movement was in line with its peers, on dovish/hawkish central bank comments.”
These are common statements you may hear on any given day as you flip past a financial news channel on your TV or scan the headlines in your newspaper. But what are equity benchmarks? What happens when a company misses earnings targets or gets upgraded or downgraded by analysts? What does any of this stuff mean to you, as a potential or new investor?
In this article, we are going to focus on building an understanding of some of the things you may typically hear in financial news. Then we are going to learn how to separate what actually matters from what is nothing more than "noise”.
Every publicly traded company, when its shares are issued, are given a price – an assignment of their value that ideally reflects the value of the company itself. The price of a stock will go up and down in relation to a number of different factors, including changes within the economy as a whole, changes within industries, political events, war, and environmental changes.
The stock price is the highest amount someone is willing to pay for the stock, or the lowest amount that it can be bought for.
"Noise" versus news
Anyone interested in keeping up with current business events has plenty of opportunity. You often see all kinds of newspapers and magazine titles dedicated to the business world. Television offers several business news channels. And the Internet provides countless business and financial web sites.
Oftentimes, events in the news cause stock prices to move both up and down, sometimes dramatically. Sometimes the market's reaction to the headlines is warranted; many other times, it's not. For an investor, the real challenge is deciphering all of the headlines and stories to determine what is really relevant for your stocks.
When digesting any event that affects any given company, the most crucial question every news outlets tries to answer is, "Does this information affect the long-term competitive advantages and resulting cash flow of this company? Does it change the stock's long-term investing prospects?"
This is key to understanding the investment process. Periodically, news will break that does not affect a company's long-term competitive advantages, but its stock price will fall anyway. This may lead to a buying opportunity. Remember, markets tends to be quite temperamental, and not always rightfully so.
The term "bull" or "bullish" comes from the bull, who strikes upward with his horns, thus pushing prices higher. A bull market is when an investment's price is rising – called an uptrend (or upward trends) – typically over a sustained period, such as months or years.
If a government official is said to have a "dovish stance", then this means that they are in favour of maintaining low interest rates in an effort to stimulate the economy. They are not particularly worried about inflation. The opposite of a dove is a "hawk".
Being hawkish is when the government stance is guarding against excessive inflation. This means that the Fed is either raising rates, or that they're considering it. Dovish, on the other hand, is basically the opposite of hawkish.
Understanding the narrative is key
There is noise and commotion followed by a narrative that may or may not make sense. Narratives follow prices because readers want an explanation, and a consensus eventually emerges.
This consensus forms a narrative, and the consensus is also embedded in market prices. Since investors look to the future, market prices imply a set of assumptions and probabilities about what will happen.
These assumptions may be optimistic or pessimistic, and these assumptions may be coherent or incoherent. Either way, consensus expectations are a logical starting point for putting any financial news in the proper context.
A liability is something a person or company owes, usually a sum of money. Liabilities are settled over time and is typically an amount owed by a company or an individual to a supplier, bank, lender, or other provider of goods, services, or loans.
An expense is the cost of an asset used by a company in its operations to produce revenues. In other words, an expense is the use of assets to create sales.
Cash flow is the total amount of money being transferred into and out of a business, especially as affecting liquidity.
Negative earnings surprises
When it comes to business news, there are numerous professionals whose job is to analyse companies and provide opinions about them and estimates about their future financial results.
While most of them are very intelligent individuals who have a wealth of information and experience, the viewpoints tend to be much too short-sighted. These analysts typically will come up with "earnings estimates" for the upcoming three-month period.
If a company's actual results fall short of analysts' expectations, this is known as a "negative earnings surprise". On such disappointing news, the company's stock price may fall. (Conversely, if a company performs better than what analysts expect, it will have a "positive earnings surprise," which may cause the stock price to increase.)
Does this disappointing shopping season mean that Walmart's long-term competitive advantages have been eroded? Probably not.
Walmart remains the largest retailer in the world, with great economies of scale and a big distribution network, which allows the company to pass huge cost savings on to customers, which, in turn, keeps customers coming back. The figures falling slightly below analysts' estimates in one particular quarter isn’t a big deal!
Analyst upgrades or downgrades
In addition to providing estimates of what they think a company's sales and earnings will be, analysts also provide recommendations for stocks they cover, such as "Buy," "Hold," or "Sell."
When an analyst changes his or her rating for a company's stock, the stock price often moves in the direction of the change. Does this upgrade or downgrade affect the business prospects of the company?
No, the opinion of one person does not alter the intrinsic value of the firm, which is determined by the company's cash flows. But maybe the analyst made the change because he or she thought the company's business prospects have deteriorated, based on research. Maybe that's right, maybe not.
Revenue is the total amount of income generated by the sale of goods or services, while income is earnings or profit – revenue minus expenses.
If the company’s pays dividends, regular payments are made to shareholders for every share held.
Newsworthy events
Other times investors will hear about events that have them running for cover, and rightfully so. One such event is the announcement of a regulatory investigation by a top government organisation.
While such announcements by themselves by no means predict impending doom, who knows what nasty surprises may lurk for investors as regulators start turning over rocks?
In recent history, plenty of investors have been burned badly by such investigations, including US energy giant Enron, scandals at Lehman Brothers, then the fourth-largest investment bank in the US and other firms in the wake of the financial crisis, and those involving Malaysian state investment fund 1Malaysia Development Berhad (1MDB).
Lehman Brothers used a high-debt business model that required it to raise billions of dollars every day to keep the doors open. In 2006, it had invested heavily in high-risk real estate mortgages. When these markets turned south, Lehman couldn’t raise enough cash to stay in business.
The 1Malaysia Development Berhad scandal is an ongoing political scandal occurring in Malaysia. In 2015, Malaysia's then-Prime Minister was accused of channelling over 2.67 billion Malaysian Ringgit from 1MDB, a government-run strategic development company, to his personal bank accounts.
Watch out for significant lawsuits
Another item to be wary of is a significant lawsuit. Corporate litigation is almost everywhere you look, and estimates of any significant legal damage are usually already priced into a stock. However, lawsuits often attract others, which could place very large uncertainties on a company's performance.
Changes in regulation can also affect the value and future prospects of a company. For instance, in addition to facing thousands of lawsuits, US cigarette maker Lorillard (LO) also faces the threat of potential increased regulation of menthol cigarettes (which account for roughly 90 per cent of its volume) from the US Food and Drug Administration.
Should the FDA choose to meaningfully restrict or ban menthol cigarettes (which the agency has been investigating), Lorillard's financial performance would likely collapse devastatingly.
A ‘Defensive’ stock is a type of stock that provides a constant rate of dividends even in the periods of economic downturn. Bonds are promissory notes issued by the government or a company to its buyers. It illustrates the specified amount held for a specified time period by the buyer.
A one-sided market is a term that refers to one that only has potential sellers or only potential buyers but not both. A sideways market, or sideways drift, occurs when the price of a n asset trades within a fairly stable range without forming any distinct trends over some period of time.
How else can news be categorised
Optimistic vs. Pessimistic: Some news sources are perpetually upbeat about business and the economy. Others are permabears (investors who consistently act in the expectation that the value of stocks and shares will fall regardless of market conditions). We need to read both varieties and make our own interpretation.
Short Term vs. Long Term: A news story could focus on stock returns for a month, a year, or a decade. Depending on the time frame chosen, the stories could come to contradictory conclusions. The contrast led to illuminating discussions or heated debates, depending on the personalities involved.
Reported Results vs. Investor Expectations: One story might say that a company’s earnings rose 20 per cent last quarter; another that the company missed expectations. Both stories are true, but the implications are quite different.
