This is the second in a series of posts from Peloton Wealth Strategists which will form Peloton’s Investment Glossary, intended to help investors understand some of the most common and confusing investment terms. We’ve shared the facts, plus our own perspective on the terms. Our goal is to help you – the investor – become a more knowledgeable consumer of financial services.

D

Day Trader: Someone who attempts to profit from intraday moves in stocks by placing many and/or large trades, often closing out all positions by the end of the trading session. Peloton’s Take: Very few individuals are ever consistently successful day trading. One reason is because often professional traders at large firms are on the other sides of these trades. Don’t do it.

Deferred Load: A sales commission that is incurred when an investment product is sold; most often associated with B-share mutual funds.  See also A Shares, B Shares, C shares.

Derivatives: Financial contracts that derive their value from the price of an underlying security, commodity, or other entity. Common derivatives include “options” on stocks. Options are contracts to buy or sell a stock at a certain price on a certain future date. Derivatives can be used to hedge risk, structure income, or speculate. Peloton’s Take: Derivatives are ingenious instruments that make modern finance possible. They can also be very complicated and dangerous if misused. See also: Call Option, Futures Contract.

Dividends: The portion of the company’s profits that are returned to shareholders as cash. Peloton’s Take: We believe dividends are an important source of cash flow for clients taking distributions from their portfolios, and work to make sure that companies we invest in can afford to continue paying their dividends. See also: Dividend Reinvestment.

Dividend Reinvestment: A custodial or mutual fund account option which allows for the automatic purchase of more shares each time a dividend is paid.

Dividend Yield: A company’s dividend expressed as a percentage of the company’s stock price. Bottom Line: Stocks with high dividend yields don’t necessarily make good investments. If the yield is too high, it may mean that the company is stretching (e.g. borrowing) to pay it. Dividend yield must be viewed within the context of the company’s ability to continue paying it.

Dow Composition: Perhaps the most widely recognized stock index, the Dow Jones Industrial Average, is comprised of 30 of the largest, most widely held common stocks in the U.S. Peloton’s Take: because the DJIA is a “price weighted” index, stocks with higher share prices affect the index value most. We believe a weighting based on market capitalization, as used in the S&P 500, is a better gauge of general market performance.

E

EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization. EBITDA is a modified measure of a company’s earnings often used to compare companies in different industries. Accounting concepts like depreciation can skew the actual profitability for companies with significant assets. Peloton’s Take: EBITDA is a useful tool and applicable in certain cases. EBITDA is not the same as cash flow, which also factors prominently in our fundamental valuation process.

Enterprise Value: An alternative measure of a company’s value that factors in both debt and cash on the company’s balance sheet. Enterprise Value = Market Capitalization + Total Debt – Cash.

Equity Ownership: Public companies finance themselves either by selling an ownership interest or by or by borrowing money. Common stocks represent an equity ownership stake in a business, while bonds and bank loans are examples of borrowed money. See also: Creditor vs. Equity Interest.

ETFs: Exchange Traded Funds are diversified investment vehicles that trade on an exchange like a stock. Like mutual funds, ETFs own a portfolio of other securities. Peloton’s Take: the number and varieties of ETFs have exploded in the the last decade. For beginning investors, ETFs can be a cost-effective way to get invested. Investors need to carefully study the holdings and expenses associated with ETFs before investing.

Ex Dividend Date: The date on which the declared dividend belongs to the owner of the stock. For all intents and purposes, the dividend has been “paid” as of this date, and often the stock falls by an amount similar to the dividend amount on this date. See also: Dividends, Dividend Yield.

 

F

FDIC Insurance Limit: The Federal Deposit Insurance Corporation is a government sponsored entity which guarantees bank customers against the possibility that their bank would fail. During the 2008-09 financial crisis, the limit of FDIC insurance was raised from $100,000 per account to $250,000. Bottom line: The insurance limit applies per FDIC-insured bank.

Fees: 12b-1: An annual marketing or distribution fee that is included a mutual fund’s “expense ratio” and costs typically 0.25 – 1.0%. Peloton’s Take: This is another misunderstood fee. It is paid to advisors for selling a particular class of mutual fund to their clients. Often this fee is higher than the management fee paid to actual mutual fund manager. Many advisors sell mutual funds with 12b-1 fees a way of building in a recurring, annual commission without charging a direct fee.

Fiduciary Duty: A legal requirement to act solely in the best interests of another party. Peloton’s Take: Registered investment advisors like Peloton are held to a fiduciary duty, while many brokers and other financial advisors are held to a much weaker “suitability standard.” The former requires that we make investment decisions in clients’ best interests. The latter allows commission-based advisors to recommend products that may be more expensive for clients and/or generate higher commissions for themselves as long at the investment is deemed suitable for the client. This is a huge distinction that is often overlooked or misunderstood by investors.

G

Guarantee: A formal promise or assurance (typically in writing) that certain conditions will be fulfilled. Peloton’s Take: A word that has no place in finance or investing. Be wary of any advisor or investment product that guarantees anything. See also: Annuity.