Valuation is a method of determining how much an asset or company is worth. Market value (Market capitalization), on the other hand, is simply the number of outstanding shares multiplied by the current share price (i.e. the buyer-willingness to pay a particular amount for the stock).

The valuation of a stock is based on: (Valuation does not refer to actual market price of the stock)

• Earnings of the company
• How well the company is expected to perform in the future
• How well it is performing in terms of other similar firms
• Free cash flow to the firm (FCFF) - this represents the net amount of cash that a firm generates after expenses, taxes, and any changes in operating and investing activities carried out by the firm

To understand this better, let’s take a scenario whe...

Ratio Analysis

Ratios are relationships between two numbers. For example, the ratio of current assets to total asset is one ratio related to the structure of assets. They help stakeholders assess the performance of companies, make it easier to compare their performance by using unified measures, and help investors understand the business models of companies.

Ratio analysis answers the following questions about a company:

• How is the company doing — does it make healthy profits?
• Does it use its cash and other assets in an effective manner?
• Is it highly leveraged (has taken a lot of borrowed capital) and is it capable of paying interest on this borrowed capital on time?
• What are its profit margins compared to its peers?
• Is the company cheap or expensive compared...

A financial instrument, or a security, is an asset (an item of value) that can be bought and sold freely on the market.

To make sure investors choose the right instruments for their needs, those instruments are classified into different asset classes based on their characteristics, behavior, or the regulations that affect them.

This article covers the numerous financial instruments that are available for investments and how they are divided into asset classes to offer a clarification for investors.

Asset Class

An asset class groups together financial securities (tradable financial assets that are monitored by a regulatory authority) with similar features based on factors such as:

• The maturity time (the time remaining for a financial security to expire. For a 10-year Government Treasury Bond, the maturity time is 10 years from the date when...

What is a Stock?

A stock or a share gives you a small ownership in a company — as the word “share” itself implies, you are sharing something with the company. As the company earns profits or losses, your stock price either appreciates or depreciates. For example, if a Company has 100 shares and you own 10 shares, you own 10% of the company.

Where do Stocks Fit in a Diversified Portfolio?

Stocks play a very important role in a diversified portfolio. They are dependent on the growth rate of the economy and automatically adjust for the rate of inflation (the rate at which expenses increase) and other positive macroeconomic signals. As a consequence, they offer a higher rate of return compared with traditional or debt instruments.

Consider the case of McDonald's burger, which were p...

Risk

When it comes to various financial instruments, Risk and Return go hand-in-hand. Every security has a risk and return trade-off associated with it — usually, the more the underlying risk involved, the higher the proportion of returns that are likely to occur in the future.

We'll briefly cover risk here, but will go into more detail in a later tutorial.

Risks can be divided broadly into two types:

Unsystematic Risk

Also known as “Diversifiable Risk”, it is the risk which an asset or security carries due to the industry’s or company’s performance in general. For example, if you have a stock portfolio with 5 stocks in it, two of which are prone to Unsystematic Risk, your por...

Fundamental Analysis

There are various techniques that are followed by investors to analyze stocks.

Fundamental analysis is a method to determine a stock price movement based on some underlying factors. The analysis could be performed on a holistic level for the industry or at an economic or global level. It helps in answering different questions, such as:

• How well has the firm performed in terms of its revenue movement?
• How competent is the firm in paying debt both in the short and long term?
• How profitable is the firm using different metrics and what projections can be made regarding future movement of the stock using the current financial statements?

Fundamental analysis takes into account factors like