InvestZ Archives | Page 38 of 183

Nov

2023

Understanding Economic Indicators

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

An economic indicator is a statistic or piece of data that offers insight into an economy. Analysts use economic indicators to gauge where an economic system is in the present moment, and where it might head next. Governments use economic indicators as guideposts when assessing monetary or fiscal policies, and corporations use them to make business decisions. Individual investors can also look to these indicators as they shape their portfolios.

There are different types of economic indicators and understanding how they work can make it easier to interpret them, and fold them into your investing strategy.

What Is an Economic Indicator?

An economic indicator is typically a macroeconomic data point, statistic, or metric used to analyze the health of an individual economy or the global economy at large. Government agencies, universities, and independent organizations can collect and organize economic indicator data.

In the United States, the Census Bureau, Bureau of Economic Analysis (BEA) and the Bureau of Labor Statistics (BLS) are some of the entities that aggregate economic indicator data.

Some of the most recognizable economic indicators examples include:

• Gross domestic product (GDP)

• Personal income and real earnings

• International trade in goods and services

• U.S. import and expert prices

• Consumer prices (as measured by the Consumer Price Index or CPI)

• New residential home sales

• New home construction

• Rental vacancy rates

• Home ownership rates

• Business inventories

• Unemployment rates

• Consumer confidence

Private organizations also regularly collect and share economic data investors and economists may use as indicators. Examples of these indicators include the Fear and Greed Index, existing home sales, and the index of leading economic indicators.

Together, these indicators can provide a comprehensive picture of the state of the economy and shine light on potential opportunities for investors.

How Economic Indicators Work

Economic indicators work by measuring a specific component of the economy over a set time period. An indicator may tell you what patterns are emerging in the economy — or confirm the presence of patterns already believed to be established. In that sense, these indicators can serve as a thermometer of sorts for gauging the temperature of the economic environment or where an economy is in a given economic cycle.

Economic indicators can not predict future economic or market movements with 100% accuracy. But they can be useful when attempting to identify signals about which way the economy (and the markets) might head next.

For example, an investor may study an economic indicator like consumer prices when gauging whether inflation is increasing or decreasing. If the signs point to a steady rise in prices, the investor might then adjust their portfolio to account for higher inflation. As prices rise, purchasing power declines but investors who are conscious of this economic indicator could take action to minimize negative side effects.

Types of Economic Indicators

Economic indicators are not all alike in terms of what they measure and how they do it. Different types of economic indicators can provide valuable information about the state of an economy. Broadly speaking, they can be grouped into one of three categories: Leading, lagging, or coincident.

Leading Indicators

Leading indicators are the closest thing you might get to a crystal ball when studying the markets. These indicators pinpoint changes in economic factors that may precede specific trends.

Examples of leading indicators include:

• Consumer confidence and sentiment

• Jobless claims

• Movements in the yield curve

• Stock market volatility

A leading indicator doesn’t guarantee that a particular trend will take shape, but it does suggest that conditions are ripe for it to do so.

Lagging Indicators

Lagging indicators are the opposite of leading indicators. These economic indicators are backward-looking and highlight economic movements after the fact.

Examples of lagging indicators include:

• Gross national product (GNP)

• Unemployment rates

• Consumer prices

• Corporate profits

Analysts look at lagging indicators to determine whether an economic pattern has been established, though not whether that pattern is likely to continue.

Coincident Indicators

Coincident indicators measure economic activity for a particular area or region. Examples of coincident indicators include:

• Retail sales

• Employment rates

• Real earnings

• Gross domestic product

These indicators reflect economic changes at the same time that they occur. So they can be useful for studying real-time trends or patterns.

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Popular Economic Indicators

There are numerous economic indicators the economists, analysts, institutional and retail investors use to better understand the market and the direction in which the economy may move. The Census Bureau, for example, aggregates data for more than a dozen indicators. But investors tend to study some indicators more closely than others. Here are some of the most popular economic indicators and what they can tell you as an investor.

Gross Domestic Product

Gross domestic product represents the inflation-adjusted value of goods and services produced in the United States. This economic indicator offers a comprehensive view of the country’s economic activity and output. Specifically, gross domestic product can tell you:

• How fast an economy is growing

• Which industries are growing (or declining)

• How the economic activity of individual states compares

The Bureau of Economic Analysis estimates GDP for the country, individual states and for U.S. territories. The government uses GDP numbers to establish spending and tax policy, as well as monetary policy, at the federal levels. States also use gross domestic product numbers in financial decision-making.

Consumer Price Index

The Consumer Price Index or CPI measures the change in price of goods and services consumed by urban households. The types of goods and services the CPI tracks include:

• Food and beverages

• Housing

• Apparel

• Transportation

• Medical care

• Recreation

• Education

• Communications

CPI data comes from 75 urban areas throughout the country and approximately 23,000 retailers and service providers. This economic indicator is the most widely used tool for measuring inflation. According to the Bureau of Labor Statistics, which compiles the consumer price index, it’s a way to measure a government’s effectiveness in managing economic policy.

Producer Price Index

The Producer Price Index or PPI measures the average change over time in the selling prices received by domestic producers of goods and services. In simpler terms, this metric measures wholesale prices for the sectors of the economy that produce goods, including:

• Mining

• Manufacturing

• Agriculture

• Fishing

• Forestry

• Construction

• Natural gas and electricity

The Producer Price Index can help analysts estimate inflation, as higher prices will show up on the wholesale level first before they get passed on to consumers at the retail level.

Unemployment Rate

The unemployment rate is an economic indicator that tells you the number of people currently unemployed and looking for work. The BLS provides monthly updates on the unemployment rate and nonfarm payroll jobs. Together, the unemployment rate and the number of jobs added or lost each month can indicate the state of the economy.

Higher unemployment, for example, generally means that the economy isn’t creating enough jobs to meet the demand by job seekers. When the number of nonfarm payroll jobs added for the month exceeds expectations, on the other hand, that can send a positive signal that the economy is growing.

Consumer Confidence

The Consumer Confidence Index can provide insight into future economic developments, based on how households are spending and saving money today. This indicator measures how households perceive the economy as a whole and how they view their own personal financial situations, based on the answers they provide to specific questions.

When the indicator is above 100, this suggests consumers have a confident economic outlook, which may make them more inclined to spend and less inclined to save. When the indicator is below 100, the mood is more pessimistic and consumers may begin to curb spending in favor of saving.

The Consumer Confidence Index is separate from the Consumer Sentiment Index, which is also used to gauge how Americans feel about the economy. This index also uses a survey format and can tell you how optimistic or pessimistic households are and what they perceive to be the biggest economic challenges at the moment.

Retail Sales

Retail sales are one of the most popular economic indicators for judging consumer activity. This indicator measures retail trade from month to month. When retail sales are higher, consumers are spending more money. If more spending improves company profits, that could translate to greater investor confidence in those companies, which may drive higher stock prices.

On the other hand, when retail sales lag behind expectations the opposite can happen. When a holiday shopping season proves underwhelming, for example, that can shrink company profits and potentially cause stock prices to drop.

Housing Starts

Census Bureau compiles data on housing starts. This economic indicator can tell you at a glance how many new home construction projects in a given month. This data is collected for single-family homes and multi-family units.

Housing starts can be useful as an economic indicator because they give you a sense of whether the economy is growing or shrinking. In an economic boom, it’s not uncommon to see high figures for new construction. If the boom goes bust, however, new home start activity may dry up.

It’s important to remember that housing starts strongly correlate to mortgage interest rates. If mortgage rates rise in reaction to a change in monetary policy, housing starts may falter, which makes this economic indicator more volatile than others.

Interest Rates

Federal interest rates are an important economic indicator because of the way they’re used to shape monetary policy. The Federal Reserve makes adjustments to the federal funds rate — which is the rate at which commercial banks borrow from one another overnight–based on what’s happening with the economy overall. These adjustments then trickle down to the interest rates banks charge for loans or pay to savers.

For example, when inflation is rising or the economy is growing too quickly, the Fed may choose to raise interest rates. This can have a cooling effect, since borrowing automatically becomes more expensive. Savers can benefit, however, from earning higher rates on deposits.

On the other hand, the Fed may lower rates when the economy is sluggish to encourage borrowing and spending. Low rates make loans less expensive, potentially encouraging consumers to borrow for big-ticket items like homes, vehicles, or home improvements. Consumer spending and borrowing can help to stimulate the economy.

Stock Market

The stock market and the economy are not the same. But some analysts view stock price and trading volume as a leading indicator of economic activity. For example, investors look forward to earnings reports as an indicator of a company’s financial strength and health. They use this information about both individual companies and the markets as a whole to make strategic investment decisions.

If a single company’s earnings report is above or below expectations, that alone doesn’t necessarily suggest where the economy might be headed. But if numerous companies produce earnings reports that are similar, in terms of meeting or beating expectations, that could indicate an economic trend.

If multiple companies come in below earnings expectations, for example, that could hint at not only lower market returns but also a coming recession. On the other hand, if the majority of companies are beating earnings expectations by a mile, that could signal a thriving economy.

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The Takeaway

Economic indicators can provide a significant amount of insight into the economy and the trends that shape the markets. Having a basic understanding of the different types of economic indicators could give you an edge if you’re better able to anticipate market movements when you start investing.

Economic indicators aren’t perfect, and while they can be a helpful part of an investing strategy, investors should always do as much research as they can before making specific moves. Discussing a strategy with a financial professional may be a good idea, too.

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FAQ

What are the leading economic indicators?

There are several leading economic indicators in the U.S., and they include consumer confidence and sentiment, jobless claims, movements in the yield curve, and stock market volatility.

What are the big three macro indicators?

While they may not be “the” big three macro indicators, a few of the key macroeconomic indicators that are often cited are gross domestic product (GDP), the unemployment rate, and the Consumer Price Index (CPI).

Photo credit: iStock/FG Trade

Nov

2023

A Guide to Financial Securities Licenses

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

Before someone can sell securities or offer financial advice they must first obtain the appropriate securities license. The Financial Industry Regulatory Authority (FINRA) is the organization that sets the requirements, oversees the process for earning an investments license, and administers most of the tests.

If you’re considering a career in the financial services industry it’s important to understand how securities licensing and registration works. Investors may also benefit from understanding what the various FINRA licenses signify when selecting an advisor.

Key Points

• Securities licenses are required for individuals to sell securities and offer financial advice.

• The Financial Industry Regulatory Authority (FINRA) sets the requirements and administers most of the tests for earning securities licenses.

• Different licenses allow financial professionals to offer a range of financial products and services to clients.

• The North American Securities Administrators Association (NASAA) is responsible for licensing investment advisor firms and enforcing state securities law.

• Some common FINRA licenses include Series 6, Series 7, Series 3, Series 63, Series 65, and Series 66, each with its own specific focus and requirements.

What Is a Securities License and Who Needs Them?

A securities license is a license that allows financial professionals to sell securities and/or offer financial advice. The type of license someone holds can determine the range of financial products and services they have authorization to offer to clients. Someone who holds one or more securities or investments licenses is a registered financial professional.

FINRA is the non-governmental agency responsible for overseeing the activities of registered financial professionals. That includes individuals who hold FINRA licenses to sell securities or offer advisory services. Individual investors do not need a license to buy and sell stocks.

Under FINRA rules, anyone who’s associated with a brokerage firm and engages in that firm’s securities business must have a license.

Some specific examples of individuals who might need to have a license from FINRA include:

• Registered Investment Advisors (RIAs)

• Financial advisors who want to sell mutual funds, annuities, and other investment packages on a commission-basis

• Investment bankers

• Fee-only financial advisors who only charge for the services they provide

• Stockbrokers and commodities or futures traders

• Advisors who oversee separately managed accounts

• Individuals who want to play an advisory or consulting role in mergers and acquisitions

• IPO underwriters

The North American Securities Administrators Association (NASAA) represents state securities regulators in the United States, Canada, and Mexico. This organization is responsible for licensing investment advisor firms and securities firms at the state level, registering certain securities offered to investors, and enforcing state securities law.

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Types of FINRA Licenses

FINRA offers a number of different securities licenses. If you’re considering a career in securities trading, it’s important to understand which one or ones you might need. The appropriate license will depend on the type of securities that you want to sell, how you’ll get paid, and what (if any) other services you’ll provide to your clients.

Here’s a rundown of some of the most common FINRA licenses, what they’re used for and how to obtain one:

Series 6

FINRA offers the Series 6 Investment Company and Variable Contracts Products Representative Exam for individuals who work for investment companies and sell variable contracts products. The types of products you can sell while holding this securities license include:

• Mutual funds (closed-end funds on the initial offering only)

• Variable annuities

• Variable life insurance

• Unit investment trusts (UITs)

• Municipal fund securities, including 529 plans

Obtaining this FINRA license requires you to also pass the introductory Securities Industry Essentials (SIE) exam. This 75-question exam tests your basic knowledge of the securities industry. FINRA offers a practice test online to help you study for the SIE. You can also watch a tutorial to learn how the 50-question Series 6 exam works.

Beyond those options you may consider investing in a paid Series 6 study prep course. Series 6 courses can help you familiarize yourself with the various variable products you can sell with this license and industry best practices. You’ll need to obtain a score of at least 70 to pass both the SIE and the Series 6 exam.

Series 7

People who see stocks and other securities must take the Series 7 General Securities Representative Exam. A Series 7 investments license is typically needed to sell:

• Public offerings and/or private placements of corporate securities (i.e. stocks and bonds)

• Rights

• Stock warrants

• Mutual funds

• Money market funds

• Unit investment trusts

• Exchange-traded funds (ETFs)

• Real estate investment trusts (REITs)

• Options on mortgage-backed securities

• Government securities

• Repos and certificates of accrual on government securities

• Direct participation programs

• Venture capital

• Municipal securities

• Hedge funds

This securities license offers the widest range, in terms of what you can sell.

You’ll need to take and pass the SIE to obtain a Series 7 exam. The Series 7 exam has 125 questions in a multiple choice format and 72% is a passing score. FINRA offers a content outline you can review to get a feel for what’s included on the exam. You may also benefit from taking a study course that covers the various securities you’re authorized to sell with the Series 7 license as well as the ethical and legal responsibilities the license conveys.

Series 3

Investment professionals can earn the Series 3 license by completing the Series 3 National Commodities Futures Exam. This test focuses on the knowledge necessary to sell commodities futures. This is a National Futures Association (NFA) exam administered by FINRA. It has 120 multiple choice questions, with 70% considered a passing score.

You have to pass the Series 3 license exam to join the National Futures Association. In terms of what’s included in the exam and how to study for it, the test is divided into these subjects:

• Futures trading theory and basic functions terminology

• Futures margins, options premiums, price limits, futures settlements, delivery, exercise and assignment

• Types of orders

• Hedging strategies

• Spread trading strategies

• Option hedging

• Regulatory requirements

Neither FINRA nor the NFA offer detailed study guides or practice tests for the Series 3 securities license. But you can purchase study prep materials online.

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Series 63

The Series 63 Uniform Securities Agent State Law Exam is an NASAA exam administered by FINRA. The test has 60 questions, of which you’ll need to get at least 43 correct in order to pass with a score of 72%.

You’ll need this license if you also hold a Series 6 or Series 7 license and you want to sell securities in any state. The NASAA offers a downloadable study guide that offers an overview of what’s included on the Series 63 securities license exam. Topics include:

• Regulation of investment advisors

• Regulation of broker-dealers

• Regulation of securities and issuers

• Communication with customers and prospects

• Ethical practices

Beyond that, the NASAA offers a list of suggested vendors for purchasing Series 63 exam study materials. But it doesn’t specifically endorse any of these vendors or their products for individuals who plan to obtain a Series 63 license.

Series 65

The Series 65 Uniform Investment Adviser Law Exam is another NASAA test that’s administered by FINRA. Holding this license allows you to offer services as a financial planner or a financial advisor on a fee-only basis. The exam has 130 multiple choice questions and you’ll need to get at least 92 questions correct to pass.

As with the Series 63 exam, the NASAA offers a study guide for the Series 65 exam that outlines key topics. Some of the things you’ll need to be knowledgeable about include:

• Basic economic concepts and terminology

• Characteristics of various investment vehicles, such as government securities and asset-backed securities

• Client investment recommendations and strategies

• Regulatory and ethical guidelines

You can review a list of approved vendors for Series 65 study materials on the NASAA website.

Series 66

The Series 66 Uniform Combined State Law Exam is the third NASAA exam administered by FINRA. Financial professionals who want to qualify as both securities agents and investment adviser representatives take this test.

This multiple choice exam has 100 questions and you’ll need a score of 73 correct or higher to pass. If you already hold a Series 7 license, which is a co-requisite, you could choose to take the Series 66 exam in place of the Series 63 and Series 65 exams.

The study guide and the scope of what the Series 66 exam covers is similar to the Series 65 exam. So if you hold a Series 65 license already, you may have little difficulty in studying and preparing for the Series 66 exam.

The Takeaway

Earning a securities license could help to further your career if you’re interested in the financial services industry. Knowing which license you need and how to qualify for it is an important first step.

Fortunately, you don’t need to hold a FINRA license to invest for yourself. For instance, you could do some research and work at building a diversified portfolio.

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Nov

2023

Understanding Market Capitalization

By Austin Kilham | Growing Wealth, invest, Investing, Terminology | Comments Off

What Is Market Capitalization?

Market capitalization (market cap) represents the total market value of a company’s outstanding shares. A company’s market capitalization, or market cap, provides a good measure of its size and value versus revenue or sales figures.

Knowing what the market cap is for a given company can help investors compare it to other companies of a similar size.

Note the market cap (the value of a company’s total equity) is different than a company’s market value, which is a more complex calculation based on various metrics, including return-on-equity, price-to-earnings, and more.

Key Points

• Market capitalization (market cap) represents the total market value of a company’s outstanding shares and provides a measure of its size and value.

• Market cap helps investors compare companies of similar size and evaluate their potential risk and reward.

• Companies are categorized into small-cap, mid-cap, large-cap, and mega-cap based on their market cap range.

• Smaller companies (nano-cap and micro-cap) can be riskier but offer growth opportunities, while larger companies (large-cap and mega-cap) tend to be more stable.

• Market cap can be calculated by multiplying the current price per share by the number of outstanding shares.

Market-Cap Categories

Analysts, as well as index and exchange-traded fund (ETF) providers commonly sort stocks into small-, mid-, and large-cap stocks, though some include a broader range that goes from micro or nano-cap stocks all the way to mega cap on the large end.

The size limits of these categories can change depending on market conditions but here are some rough parameters.

Nano-cap and Micro-cap Stocks

Nano- and micro-cap companies are those with a total market capitalization under $300 million. Some define nano-cap stocks as those under $50 million, and micro-cap stocks as those between $50 million and $300 million.

These smaller companies can be riskier than large-cap companies (though not always). Many microcap stocks trade over-the-counter (OTC). Over-the-counter stocks are not traded on a public exchange like the New York Stock Exchange (NYSE) or Nasdaq. Instead, these stocks are traded through a broker-dealer network.

As a result there may be less information available about these companies, which can make them difficult to assess.

Small-cap Stocks

Small-cap companies are considered to be in the $300 million to $2 billion range. They are generally younger and faster-growing than large-cap stocks. Investors often look to small-caps for growth opportunities.

While small-cap companies have historically outperformed large-caps, these stocks can also be more risky, and may require more due diligence from would-be investors.

Mid-cap

Mid-cap companies lie between small- and large-cap companies, with market caps of $2 billion to $10 billion.

Some investors may find mid-cap stocks attractive because they can offer some of the growth potential of small-caps with some of the maturity of large-caps. But mid-cap stocks likewise can share some of the downsides of those two categories, being somewhat vulnerable to competition in some cases, or lacking the impetus to expand in others.

Large-cap

Large-cap stocks are those valued between $10 billion and $200 billion, roughly. Large-cap companies tend not to offer the same kind of growth as small- and mid-cap companies. But what they may lack in performance they can deliver in terms of stability.

These are the companies that tend to be more well established, less vulnerable to sudden market shocks (and less likely to collapse). Some investors use large-cap stocks as a hedge against riskier investments.

Mega-cap

Mega cap describes the largest publicly traded companies based on their market capitalization. Mega cap stocks typically include industry-leading companies with highly recognizable brands with valuations above $200 billion.

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How to Calculate Market Cap

To figure out a company’s market cap, simply multiply the number of outstanding shares by the current price per share. If a company has 10 million outstanding shares of stock selling for $30 per share, the company’s market cap is $300 million.

Share prices fluctuate constantly, and as a result, so does market cap. You should be able to find the number of outstanding shares listed on a company’s balance sheet, where it’s referred to as “capital stock.” Companies update this number on their quarterly filings with the Securities and Exchange Commission (SEC).

Market Cap Formula

The formula for determining a company’s market cap is fairly simple:

Current price per share x Total # of outstanding shares = Market capitalization

Remember that the share price doesn’t determine the size of the company or vice versa. When measuring market cap you always have to look at the share price multiplied by the number of outstanding shares.

• Company A could be worth $100 per share, and have 50,000 shares outstanding, for a total market cap of $5 million.

• Company B could be worth $25 per share, and have 20 million shares outstanding, for a total market cap of $500 million.

Market Cap and Number of Shares

In some cases, market cap can change if the number of stocks increases or decreases. For example, a company may issue new stock or even buy back stock. When a company issues new shares, the stock price may dip as investors worry about dilution.

Stock splits do not increase market share, because the price of the stock is also split proportionally.

Changes to the number of shares are relatively rare, however. More commonly, investors will notice that changes in share price have the most frequent impact on changing market cap.

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Market Cap Versus Stock Price

If you’re new to investing, you may assume a company’s share price is the clearest indicator of how large a company is. You may even assume it’s as important in choosing a stock as market cap.

While the share price of a company tells you how much it costs to own a piece of the company, it doesn’t really give you any hints as to the size of the company or how much the company is worth.

Market cap, on the other hand, might give you some hints about how a particular stock might behave. For example, large companies may be more stable and experience less volatility than their smaller counterparts.

Recommended: Intrinsic Value vs. Market Value

Evaluate Stocks Using Market Cap

Understanding the market cap of a company can help investors evaluate the company in the context of other companies of similar size.

For instance, as noted above market cap can clue investors into stocks’ potential risk and reward, in part because the size of a company can be related to where that company is in its business development. Investors can also evaluate how a company is doing by comparing its performance to an index that tracks other companies of a similar size, a process known as benchmarking.

• The S&P 500, a common benchmark, is a market-cap weighted index of the 500 largest publicly traded U.S. companies.

• The S&P MidCap 400, for example, is a market-cap weighted index that tracks mid-cap stocks.

• The Russell 2000 is a common benchmark index for small cap stocks.

Within this system, companies with higher market cap make up a greater proportion of the index. You may often hear the S&P 500 used as a proxy for how the stock market is doing on the whole.

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What Market Cap Can Tell You

Here are some characteristics of larger market-cap companies versus smaller-cap stocks:

Volatility: Larger companies, also often dubbed blue-chip stocks, tend to be less volatile than smaller stocks and tend to offer steady returns. What’s more, compared to larger companies, they have relatively few resources, such as access to cheaper credit and access to liquidity.

Revenue: Larger stocks tend to have more international exposure when it comes to their sales and revenue streams. Meanwhile, smaller stocks can be more oriented to the domestic economy.

Growth: Smaller companies tend to have better odds of offering faster growth.

Valuation: Larger stocks tend to be more expensive than smaller ones and have higher valuations when it comes to metrics like price-to-earnings ratios.

Dividends: Many investors are also drawn to large cap stocks because companies of this size frequently pay out dividends. When reinvested, these dividends can be a powerful driver of growth inside investor portfolios.

Market Cap and Diversification

So how do you use market cap to help build a portfolio? Market cap can help you choose stocks that could help you diversify.

Building a diversified portfolio made up of a broad mix of investments is a strategy that can help mitigate risk.

That’s because different types of investments perform differently over time and depending on market conditions. This idea applies to stock from companies of varying sizes, as well. Depending on market conditions, small, medium, and large cap companies could each beat the market or trail behind.

Because large-cap companies tend to have more international exposure, they might be doing well when the global economy is showing signs of strength. On the flip side, because small-cap companies tend to have greater domestic exposure, they might do well when the U.S. economy is expected to be robust.

Meanwhile, larger-cap companies could also be outperforming when there’s a downturn, because they may have more cash at hand and prove to be resilient. In recent years, the biggest companies in the U.S. have been linked to the technology. Therefore, picking by market cap can have an impact on what kind of sectors are in an investor’s portfolio as well.

What Is Free-Float Market Cap?

Float is the number of outstanding shares that are available for trading by the public. Therefore, free-float market cap is calculating market cap but excluding locked-in shares, typically those held by company executives.

For example, it’s common for companies to provide employees with stock options or restricted stock units as part of their compensation package. These become available to employees according to a vesting schedule. Before vesting, employees typically don’t have access to these shares and can’t sell them on the open market.

The free-float method of calculating market cap excludes shares that are not available on the open market, such as those that were awarded as part of compensation packages. As a result, the free-float calculation can be much smaller than the full market cap calculation.

However, this method could be considered to be a better way to understand market cap because it provides a more accurate representation of the movement of stocks that are currently in play. Many of the major indexes, such as the S&P 500 and the MSCI indices, use the free-float method.

Market Cap vs Enterprise Value

While market cap is the total value of shares outstanding, enterprise value includes any debt that the company has. Enterprise value also looks at the whole value of a company, rather than just the equity value.

Here is the formula for enterprise value (EV):

Market cap + market value of debt – cash and equivalents.

A more extended version of EV is here:

Common shares + preferred shares + market value of debt + minority interest – cash and equivalents.

The Takeaway

Market capitalization is a common way that analysts and investors describe the value and size of different companies. Market cap is simply the price per share multiplied by the number of outstanding shares. Given that prices fluctuate constantly, so does the market cap of each company, but the parameters are broad enough that investors generally know whether a company is a small cap vs. a mid cap vs. a large or mega cap.

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FAQ

What is the maximum market cap?

In theory there is no cap on market cap; i.e. there is no maximum size a company can be. As of Aug. 21, 2023, the top five biggest companies by market cap, according to Forbes, are: Apple ($2.744 trillion), Microsoft ($2.353 trillion), Saudi Aramco ($2.224 trillion), Alphabet (Google) ($1.624 trillion), Amazon ($1.336 trillion).

How does market cap go up?

A company’s market cap can grow if the share price goes up.

Are large-cap stocks good?

The market cap of any company is neither good nor bad; it’s simply a way to measure the company’s size and value relative to other companies in the same sector or industry. You can have mega cap companies that underperform and micro-cap companies that outperform.

Nov

2023

Class A vs Class B vs Class C Shares, Explained

By Anna Davies | Growing Wealth, invest, Investing, Terminology | Comments Off

Broadly speaking, Class A, Class B, and Class C shares are different categories of company that have different voting rights and different levels of access to distributions and dividends. Companies may use these tiers so that certain key shareholders, such as founders or executives, have more voting power than ordinary shareholders. These shareholders also may have priority on the company’s profits and assets, and may have different access to dividends.

Not all companies have alternate stock classes. And what can make share categories even more complicated is that while the classifications are common, each company can define their stock classes, meaning that they can vary from company to company. That makes it even more important for investors to know exactly what they’re getting when they purchase a certain type of stock. Understanding how different share classes typically differ can help when making investment decisions or analyzing business news.

Key Points

• Class A, Class B, and Class C shares are different categories of company stock with varying voting rights and access to dividends.

• Companies may use different share classes to give certain shareholders more voting power and priority on profits.

• Share classes can vary from company to company, making it important for investors to understand the specific terms and differences.

• Class A shares generally have more voting power and higher priority for dividends, while Class B shares are common shares with no preferential treatment.

• Class C shares can refer to shares given to employees or alternate share classes available to public investors, with varying restrictions and voting rights.

Why Companies Have Different Types of Stock Shares

When a company goes public, they are selling portions of their company, known as stocks, to shareholders.

Shareholders own a portion of the company’s assets and profits and have a say in how the company is governed. To mitigate risk and retain majority control of the company, a company can restrict the amount of stock they sell and retain majority ownership in the company. Or they can create different shareholder classes with different rights.

By creating multiple shareholder classes when they go public, a company can ensure that executives maintain control of the company and have more influence over business decisions. For example, while ordinary shareholders, or Class B shareholders, may have one vote per share owned, individuals with executive shares, or Class A shares, may have 100 votes per share owned. Executives also may get first priority of profits, which can be important in the case of an acquisition or closure, where there is only a finite amount of profit.

Different stock classes can also reward early investors. For example, some companies may designate Class A investors as those who invested with the company prior to a certain time period, such as a merger. These investors may have more votes per share and rights to dividends than Class B investors. A company’s charter, perspective, and bylaws should outline the differences between the classes.

Class differentiation has become more critical in creating a portfolio in recent years because investors have access to different classes in a way they may not have had access in the past. For example, mutual funds frequently divide their shares into A, B, and C class shares based on the type of investor they want to attract.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

The Different Types of Shares

Just like there are different types of stock, there are different types of shareholders. Because different stock classes have such different terms, depending on the company, investors may use additional terminology to describe the stock they hold. This can include:

Preferred shares

Investors who buy preferred shares may not have voting rights, but may have access to a regular dividend that may not be available to shareholders of common stock.

Common shares

Sometimes called “ordinary shares,” common shares are stocks bought and measured on the market. Owners have voting rights. They may have dividends and access to profits, though they may come after other investors, such as executive shareholders and preferred shareholders have been paid.

Nonvoting shares

These are typically offered by private companies or as part of a compensation package to employees. Companies may use non voting shares so employees and former employees don’t have an outsize influence in company decision-making, or so that power remains consolidated with the executive board and outside shareholders. Some companies create a separate class of stock, Class C stock, that comes without voting rights and that may be less expensive than other classes.

Executive shares

Typically, these shares are held by founders or company executives. Their stock may have outsize voting rights and may also have restrictions on the ability to sell the shares. Executive shares usually do not trade on the public markets.

Advisory shares

Often offered to advisors or large investors of a company, these shares may have preferred rights and do not trade on public markets.
Recommended: Shares vs. Stocks: Differences to Know

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What Are Class A Shares?

While the specific attributes of Class A shares depend on the company, they generally come with more voting power and a higher priority for dividends and profit in the event of liquidation. Class A shares may be more expensive than Class B shares, or may not be available to the general public.

Many companies can have different stock tiers that trade at different prices. For instance, Company X may have Class A stock that regularly trades at hundreds of thousands of dollars while its Class B stock may trade for hundreds of dollars per share. Class B stockholders may also only have a small percentage of the vote that a Class A stockholder has. And while Class A stockholders might be able to convert their shares into Class B shares, a Class B shareholder may not be able to convert their shares into Class A shares.

Many of the tech companies that have gone public in recent years have also used a dual-share class system.

In some cases, shareholders are not allowed to trade their Class A shares, so they have a conversion that allows the owner to convert them into Class B, which they can sell or trade. Executives may also be able to sell their shares in a secondary offering, following the IPO.

💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.

What Are Class B Shares?

Often companies refer to their Class B shares as “common shares” or “ordinary shares,” (But occasionally, companies flip the definition and have Class A shares designated as common shares and Class B shares as founder and executive shares). Investors can buy and sell common shares on a public stock exchange, where, typically, one share equals one vote. Class B shares carry no preferential treatment when it comes to dividing profits or dividends.

What Are Class C Shares?

Some companies also offer Class C shares, which they may give to employees as part of their compensation package. These shares may have specific restrictions, such as an inability to trade the shares.

Class C shares also may also refer to alternate share classes available to public investors. Often priced lower than Class A shares and with restrictions on voting rights, these shares may be more accessible to larger groups of investors. But this is not always the case. For example, Alphabet has Class A and Class C shares. Both tend to trade at similar prices.

The difference between Class C and common stock shares can be subtle. It’s important to note that these stock classes vary depending on the company. So doing research and understanding exactly which type of shares you’re buying is key before you commit to purchasing a certain class of stock.

Class A vs Class B vs Class C Shares

What Are Dual Class Shares?

Companies that offer more than one class of shares have “dual class shares.” This is a fairly common practice, and some companies offer dual class shares that automatically convert to a common share with voting privilege at a set period of time.

These may be startups who go public through IPO and do not want public investors to have a say in the company’s decision-making. There has been controversy about companies offering two share classes of stock to the public, with detractors concerned that multiple share classes may lead to governance issues, such as reduced accountability. But others argue that multiple share classes can be an asset for a public company, leading to improved performance.

The Takeaway

Class A, Class B, and Class C shares have different voting rights and different levels of access to distributions and dividends. It can be difficult to determine which investment class is the best option for you if you’re deciding to invest in a public company that offers multiple share classes. Beyond market price, understanding how the stock will function in your overall portfolio as well as your personal investing philosophy can help guide you choose the best share class for you.

For example, investors who may be looking for shorter-term investments may choose a stock class without voting privileges. Other investors who want to be active in corporate governance may prefer share classes that come with voting rights. And some investors may be looking for stocks that provide guaranteed dividends, which may guide their decision toward one class of shares.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

You may also be interested in:

Examining the Different Types of Stocks

Preferred Stock vs. Common Stock

Shares vs Stocks: What’s the Difference?

Photo credit: iStock/g-stockstudio

Nov

2023

What Is a Dead Cat Bounce and How Can You Spot It?

By Ashley Kilroy | Growing Wealth, invest, Investing | Comments Off

A “dead cat bounce” is a colorful way of describing an unexpected price jump that occurs after a long, slow decline — and typically just before another price drop.

A dead cat bounce carries that morbid name because the price spike in a particular stock or market sector isn’t “live” (i.e. it’s not a real rebound), and characteristically it doesn’t last.

The danger can be that the apparent rebound creates false value, or optimism. That said, some investors may be able to take advantage of a dead cat bounce to create a short position. Unfortunately, it’s hard to identify a dead cat bounce until after the fact.

Nonetheless, investors may want to know some of the signs of this price pattern, as it can help them gauge certain market movements.

Key Points

• A dead cat bounce refers to a temporary price jump after a decline, often followed by another drop.

• It is difficult to identify a dead cat bounce in real-time, making it challenging for investors to take advantage of it.

• Dead cat bounces can occur in individual stocks, bonds, or entire markets.

• Investors should be cautious when interpreting price movements and consider other factors before making investment decisions.

• Active investors may use technical analysis and market indicators to help identify potential dead cat bounces.

What Is a Dead Cat Bounce?

The meaning of “dead cat bounce” comes from a bleak saying among traders that even a dead cat will bounce if it’s dropped from a high enough height.

Thus, when a security or market experiences a steady decline, and then appears to bounce back, only to decline again — it’s known as a dead cat bounce. The “recovery” doesn’t have a rhyme or reason; it’s merely part of a short-term market variation, perhaps driven by market sentiment or other economic factors.

Sometimes what appears to be a dead cat bounce can turn into a stock market crash.

A Dead Cat Bounce Is Specific

If you’re learning how to invest in stocks, bear in mind that a dead cat bounce is not used to describe the ups and downs of a typical trading day — it refers to a longer-term drop, rebound, and continued drop. The term wouldn’t apply to a security that’s continuing to grow in value. The revival must be brief, before the price continues to fall.

It’s also important to point out that this financial phenomenon can pertain to individual securities such as stocks or bonds, to stock trading as a whole, or to a market.

Why Identify a Dead Cat Bounce?

Even for experienced traders or short-term investors using sophisticated technical analysis, it can be difficult. Sometimes a rally is actually a rally; sometimes a drop indicates a bottom.

The point of trying to distinguish whether the rise in price will continue or reverse is because it can influence your strategy. If you have a short position, and you anticipate that a rally in stock price will end in a reversal, you may want to hold steady. If you think the rally will continue, you’ll want to exit a short position.

Example of a Dead Cat Bounce

To illustrate a dead cat bounce, let’s suppose company ABC trades for $70 on June 5, then drops in value to $50 per share over the next four months. Between Oct. 7 and Oct. 14, the price rises to $65 per share — but then starts to rapidly decline again on Oct. 15. Finally, ABC’s stock price settles at $30 per share on Oct. 16.

This pattern is how a dead cat bounce might appear in a real-life trading situation. The security quickly paused the decline for a swift revival, but the price recovery was temporary before it started falling again and eventually steadied at an even lower price.

History of Dead Cat Bounces

There are countless examples of the dead cat bounce pattern in stocks and other securities, as well as whole markets. One of the most recent affected the entire stock market during the Covid pandemic.

The U.S. stock market lost about 12% during one week in February 2020, and appeared to revive the following week with a 2% gain. But it turned out to be a false recovery, and the market dipped back down again until later that summer.

Why Does a Dead Cat Bounce Happen?

A dead cat bounce is often the result of investors believing the market or security in question has hit its low point and they try to buy in to ride the turnaround. It can also occur as a result of investors closing out short positions.

Since these trends aren’t driven by technical factors, that’s why the bounce is typically short-lived — usually lasting a couple of days, or maybe a couple of months on the outside.

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How to Spot A Dead Cat Bounce

Because a dead cat bounce is often an illusion of actual intrinsic value, investors may be tempted to jump on an investment opportunity before it makes sense to do so.

The following typical sequence of events may help an investor correctly identify a dead cat bounce as it might occur with a specific stock.

1. There is a gap down.

Typically the stock opens lower than the previous close, usually a significant amount like 5% (or perhaps 3% if the stock isn’t prone to volatility).

2. The security’s price steadily declines.

In a true dead cat bounce scenario, that initial gap down will be followed by a sustained decline.

3. The price sees a monetary gain for a short time.

At some point during the price drop, there will be a turnaround as the price appears to bounce back, close to its previous high.

4. A security’s price begins to regress again.

The rally is short, however, and the stock completes its dead cat bounce pattern with a final decline in price.

Dead Cat Bounce vs Other Patterns

How do you know whether the pattern you’re seeing is really a classic dead cat bounce versus other types of movements? Here are some clues.

Dead Cat Bounce or Rally?

One way to stay alert for a dead cat bounce with a particular stock is to consider whether the now-rising stock is still as weak as it was when its price was falling. If there’s no market indicator as to why the stock is rebounding, it might make sense to suspect a dead cat bounce.

Dead Cat Bounce or Lowest Price?

Since investors are looking for opportunities to profit, they try to find investment opportunities that allow them to buy low and sell high.

Therefore, when assessing investment opportunities, a successful investor might try to recognize emerging companies, and buy shares of their stock while the price is low and before other investors get wind of the lucrative company.

Since companies go through business cycles where stock prices fluctuate, pinpointing the lowest price point might be hard to determine. There’s no way to know if a dead cat bounce is happening, until the prices have resumed their descent.

Dead Cat Bounce or Bottom of a Bear Market?

Investors may also confuse a dead cat bounce for the actual bottom of a bear market. It’s not uncommon for stocks to significantly rebound after the bear market hits bottom.

History shows that the S&P 500 often sees substantial gains within the first few months of hitting bottom after a bear market. But these rallies have been sustained, and thus are not a dead cat bounce.

Investing Strategies to Avoid a Dead Cat Bounce

For investors who want a more hands-on investing approach — meaning active investing vs. passive — it’s generally better to use investing fundamentals to evaluate a security instead of attempting to time the market (and risk mistaking a dead cat bounce for an opportunity).

Investors who are just starting may want to consider building a portfolio of a dozen or so securities. Picking a few stocks allows investors to monitor performance while giving their portfolio a little diversification. This means the investor distributes their money across several different types of securities instead of investing all of their money in one security, which in turn can help to minimize risk.

Active investors could also consider selecting stocks across varying sectors to give their portfolio even more diversification instead of sticking to one niche.

Investors with restricted funds might consider investing in just a few stocks while offsetting risk by investing in mutual funds or exchange-traded funds (ETFs).

For investors who would prefer not to execute an active investing strategy alone, they can speak with a professional manager. Working with a professional manager may help the investors better navigate the intricacies of various market cycles.

Limitations in Identifying a Dead Cat Bounce

As noted several times here, a dead cat bounce can’t really be identified with 100% certainty until after the fact. While some traders may believe they can predict a dead cat bounce by using certain fundamental or technical analysis tools, it’s impossible to do so every single time.

If there were a way to accurately predict market movements or different patterns, people would always try to time the market. But there are no crystal balls in investing, as they say.

The Takeaway

With 20-20 hindsight, investors and analysts can clearly see that an individual security or market has experienced a steady drop in value, a brief rebound, and then a further drop — a phenomenon known as a dead cat bounce.

Unfortunately, though, it can be too hard for most investors to distinguish between a dead cat bounce and a bona fide rally, or the bottom of a given market or security’s price. Still, knowing what to look for may help investors make more informed choices, especially when it comes to making a choice around keeping or closing out a short position.

For investors who want to take an active role in investing, an online trading platform like SoFi Invest® offers the opportunity to manage your money the way you want. When you open an Active Invest account with SoFi, you can trade stocks you’re familiar with or explore different investment opportunities, including IPO shares, fractional shares, and more.

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