I previously wrote about some of the basics of the stock market and how it works. Now I want to go over a few terms and concepts in order to understand the market better.

First of all is the market capitalization of a company or stock. If you’re familiar with mutual funds, you’ve probably heard of large or small cap stocks. A company’s market cap refers to its economic size and is determined by multiplying the stock price by the number of outstanding shares. This figure is a representation of the public’s view of the value of a company.

Large Cap stocks are typically valued at over $10 billion and small cap stocks at less than $1 billion.

When looking into individual stocks one of the most common things looked into is the company’s P/E Ratio. This stands for the price to earnings ratio. It is a measure a stock’s price relative the company’s earnings. The ratio is figured by dividing the market capitalization by the earnings, or dividing the stock price by the earnings per share (EPS). The higher this ratio, the more expensive the stock is thought to be. If the P/E ratio is 16, then you’re paying $16 for every $1 worth of earnings.

The P/E ratio is often talked about because it is a way to compare different sizes of companies to one another. It’s kind of an equalizer. In fact, ratios are often used in stock analysis for this very reason.

There’s a whole lot more to look at when you’re getting into the stock market, and I’ll probably touch on them at some point. Even if you’re more interested in mutual funds and ETFs, it wouldn’t hurt to learn about what these funds are made up of. I’m convinced that the more understanding you have, the more successful investor you’ll be.

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