Glossary

Acquisitions can be either friendly or unfriendly. Friendly acquisitions occur when the target firm agrees to be acquired; unfriendly acquisitions don’t have the same agreement from the target firm.

Acquisition Premium – The difference between the actual cost for acquiring a target firm versus the estimate made of its value before the acquisition. During a merger and acquisition, companies will first estimate the cost that they wish to pay for a target firm. Acquisition process takes many weeks, the price paid for the target firm may in fact be higher or lower than its market price at the time of completion because of economic fluctuations.

Board Of Directors (B Of D) – A group of individuals that are elected as, or elected to act as, representatives of the stockholders to establish corporate management related policies and to make decisions on major company issues. Such issues include the hiring/firing of executives, dividend policies, options policies and executive compensation. Every public company must have a Board of Directors. In general, the Board of Directors makes decisions on your behalf for the company in which you invest.

Most importantly, the Board of Directors should be a fair representation of both management and shareholder’s interests, because too many insiders serving as directors will mean the board will make decisions more beneficial to management. On the other hand, possessing too many independent directors may mean management will be left out of the decision-making process and may cause good managers to leave in frustration.

Book Value –

• The value at which an asset is carried on a balance sheet. In other words, the cost of an asset minus accumulated depreciation.
• The net asset value of a company, calculated by total assets minus intangible assets (patents, goodwill) and liabilities.
• The initial outlay for an investment. This number may be net or gross of expenses such as trading costs, sales taxes, service charges and so on.

In the U.S., book value is known as “net asset value”. Book value is the accounting value of a firm. It has two main uses:

• It is the total value of the company’s assets that shareholders would theoretically receive if a company were liquidated.
• By being compared to the company’s market value, the book value can indicate whether a stock is -under- or overpriced.
• In personal finance, the book value of an investment is the price paid for a security or debt investment. When a stock is sold, the selling price less the book value is the capital gain (or loss) from the investment.

Carve-out (Equity Carve-Out) –

• Sometimes known as a partial spin off, a carve out occurs when a parent company sells a minority (usually 20% or less) stake in a subsidiary for an IPO or rights offering.

The highest ranking executive in a company whose main responsibilities include developing and implementing high-level strategies, making major corporate decisions, managing the overall operations and resources of a company, and acting as the main point of communication between the board of directors and the corporate operations. The CEO will often have a position on the board, and in some cases he is even the chair.

There are various other titles for the position of CEO including president and executive or managing director. The role of the CEO will vary from one company to another depending on its size and organization. In smaller companies, the CEO will often have a much more hands-on role in the company, making a lot of the business decisions; even lower-level ones such as the hiring of staff. However, in larger companies, the CEO will often deal with only the higher-level strategy of the company and directing its overall growth, with most other tasks delegated to managers and departments.

Conglomerate – A corporation that is made up of a number of different, seemingly unrelated businesses. In a conglomerate, one company owns a controlling stake in a number of smaller companies, which conduct business separately. Each of a conglomerate’s subsidiary businesses runs independently of the other business divisions, but the subsidiaries’ management reports to senior management at the parent company.

The largest conglomerates diversify business risk by participating in a number of different markets, although some conglomerates elect to participate in a single industry an example is mining.

These are the two philosophies guiding many conglomerates:

By participating in a number of unrelated businesses, the parent corporation is able to reduce costs by using fewer resources.

By diversifying business interests, the risks inherent in operating in a single market are mitigated.

History has shown that conglomerates can become so diversified and complicated that they are too difficult to manage efficiently. Since the height of their popularity in the period between the 1960s and the 1980s, many conglomerates have reduced the number of businesses under their management to a few choice subsidiaries through divestiture and spinoffs.

Debt Financing – When a firm raises money for working capital or capital expenditures by selling bonds, bills, or notes to individual and/or institutional investors. In return for lending the money, the individuals or institutions become creditors and receive a promise that the principal and interest on the debt will be repaid.

The other way of raising capital is to issue shares of stock in a public offering. This is called equity financing.

Delisting – The removal of a listed security from the exchange on which it trades. Stock is removed from an exchange because the company, for which the stock is issued, whether voluntarily or involuntarily, is not in compliance with the listing requirements of the exchange.

The reasons for delisting include violating regulations and/or failing to meet financial specifications set out by the stock exchange. Companies that are delisted are not necessarily bankrupt, and may continue trading over the counter.

In order for a stock to be traded on an exchange, the company that issues the stock must meet the listing requirements set out by the exchange. Listing requirements include minimum share prices, certain financial ratios, minimum sales levels, and so on. If listing requirements are not met by a company, the exchange that lists the company’s stock will probably issue a warning of non-compliance to the company. If the company’s failure to meet listing requirements continues, the exchange may delist the company’s stock.

Depreciation – In accounting, an expense recorded to allocate a tangible asset’s cost over its useful life. Since it is a non-cash expense, it increases free cash flow while decreasing reported earnings.

• A decrease in the value of a particular currency relative to other currencies.
• Depreciation is used in accounting to try to match the expense of an asset to the income that the asset helps the company earn. For example, if a company bought a piece of equipment for $1 million and expected it to have a useful life of 10 years, it would be depreciated over the 10 years. Every accounting year, the company would expense $100,000 (assuming straight line depreciation), and this would be matched with the money that the equipment helps to make each year.
• Examples of currency depreciation are the infamous Russian ruble crisis in 1998, which saw the ruble lose 25% of its value in one day.

De-merger – A corporate strategy to sell off subsidiaries or divisions of a company.

For example, in 2001 British Telecom did a de-merger of its mobile phone arm, BT Wireless, in an attempt to boost the performance of its stock. British Telecom took this action because it was struggling under high debt levels from the wireless venture.

Dilution – A reduction in earnings per share of common stock that occurs through the issuance of additional shares or the conversion of convertible securities. Adding to the number of shares outstanding reduces the value of holdings of existing shareholders.

Discount – The condition of the price of a bond that is lower than par. The discount equals the difference between the price paid for a security and the security’s par value.

For example, if a bond with a par value of $1,000 is currently selling for $990 dollars, it is selling at a discount.

Discounted Cash Flow (DCF) – A valuation method used to estimate the attractiveness of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one.

There are many variations when it comes to what you can use for your cash flows and discount rate in a DCF analysis. Despite the complexity of the calculations involved, the purpose of DCF analysis is just to estimate the money you’d receive from an investment and to adjust for the time value of money.

DCF models are powerful, but they do have shortcomings. DCF is merely a mechanical valuation tool, which makes it subject to the axiom “garbage in, garbage out”. Small changes in inputs can result in large changes in the value of a company. Instead of trying to project the cash flows to infinity, a terminal value approach is often used. A simple annuity is used to estimate the terminal value past 10 years, for example. This is done because it is harder to come to a realistic estimate of the cash flows as time goes on.

Divestiture – The partial or full disposal of an investment or asset through sale, exchange, closure or bankruptcy. Divestiture can be done slowly and systematically over a long period of time, or in large lots over a short time period.

For a business, divestiture is the removal of assets from the books. Businesses divest by the selling of ownership stakes, the closure of subsidiaries, the bankruptcy of divisions, and so on.

In personal finance, investors selling shares of a business can be said to be divesting their interests in the company being sold.

Earnings – The amount of profits that a company produces during a specific period, which is usually defined as a quarter (three calendar months) or a year. Earnings typically refer to after-tax net income. Ultimately, a business’s earnings are the main determinant of its share price, because earnings and the circumstances relating to them can indicate whether the business will be profitable and successful in the long run.

Earnings are perhaps the single most studied number in a company’s financial statements because they show a company’s profitability. A business’s quarterly and annual earnings are typically compared to analyst estimates and guidance provided by the business itself. In most situations, when earnings do not meet either of those estimates, a business’s stock price will tend to drop. On the other hand, when actual earnings beat estimates by a significant amount, the share price will likely surge.

Earnings Multiplier – The estimated price-earnings ratio adjusted for the current level of interest rates. This is yet another variation on the P/E ratio.

Earnings Per Share (EPS) – The portion of a company’s profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company’s profitability.

In the EPS calculation, it is more accurate to use a weighted-average number of shares outstanding over the reporting term, because the number of shares outstanding can change over time. However, data sources sometimes simplify the calculation by using the number of shares outstanding at the end of the period.

Diluted EPS expands on the basic EPS by including the shares of convertibles or warrants outstanding in the outstanding shares number.

Earnings per share are generally considered to be the single most important variable in determining a share’s price. It is also a major component of the price-to-earnings valuation ratio.

For example, assume that a company has a net income of $25 million. If the company paid out $1 million in preferred dividends and had 10 million shares for one half of the year and 15 million shares for the other half, the EPS would be $1.92 (24/12.5). First, the $1 million is deducted from the net income to get $24 million. Then a weighted average is taken to find the number of shares outstanding (0.5 x 10M+ 0.5 x 15M = 12.5M).

An important aspect of EPS that’s often ignored is the capital that is required to generate the earnings (net income) in the calculation. Two companies could generate the same EPS number, but one could do so with less equity (investment) – that company would be more efficient at using its capital to generate income and, all other things being equal, would be a “better” company. Investors also need to be aware of earnings manipulation that will affect the quality of the earnings number. It is important not to rely on any one financial measure, but to use it in conjunction with statement analysis and other measures.

Economies Of Scale – The increase in efficiency of production as the number of goods being produced increases. Typically, a company that achieves economies of scale lowers the average cost per unit through increased production since fixed costs are shared over an increased number of goods.

There are two types of economies of scale:

• External economies – the cost per unit depends on the size of the industry, not the firm.
• Internal economies – the cost per unit depends on size of the individual firm.

An economy of scale gives big companies access to a larger market by allowing them to operate with greater geographical reach. For the more traditional (small to medium) companies, however, size does have its limits. After a point, an increase in size (output) actually causes an increase in production costs. This is called “diseconomies of scale”.

Enterprise-Value-To-Sales (EV/Sales) – A valuation measure that compares the enterprise value of a company to the company’s sales. EV/sales gives investors an idea of how much it costs to buy the company’s sales. This measure is an expansion of the price-to-sales valuation, which uses market capitalization instead of enterprise value. EV/sales is seen as more accurate because market capitalization does not take into account as well as enterprise value the amount of debt a company has, which needs to be paid back at some point. Generally the lower the EV/sales the more attractive or undervalued the company is believed to be.

The EV/sales measure can be negative when the cash in the company is more than the market capitalization and debt structure, signaling that the company can essentially be bought with its own cash.

The EV/sales measure can be slightly deceiving: high EV/Sales are not always a bad thing as it can be a sign that investors believe the future sales will greatly increase. Lower EV/sales can signal that the future sales prospects are not very attractive. It is important to compare the measure to that of other companies in the industry, and to look deeper into the company you are analyzing.

Employee Stock Option (ESO) – A stock option granted to specified employees of a company. ESOs carry the right, but not the obligation, to buy a certain amount of shares in the company at a predetermined price. An employee stock option is slightly different from a regular exchange-traded option because it is not generally traded on an exchange, and there is no put component. Furthermore, employees typically must wait a specified vesting period before being allowed to exercise the option.

The idea behind stock options is to align incentives between the employees and shareholders of a company. Shareholders want to see the stock appreciate, so rewarding employees when the stock goes up ensures, in theory, that everyone is striving for the same goals. Critics point out, however, that there is a big difference between an option and the ownership of the underlying stock. If the stock goes down, the holder of an option would lose the opportunity for a bonus, but wouldn’t feel the same pain as the owner of the stock. This is especially true with employee stock options because they are often granted without any cash outlay from the employee.

Another problem with employee stock options is the debate over how to value them and the extent to which they are an expense on the income statement. This is an ongoing issue in the U.S. and most countries in the developed world.

Exchange – A market in which securities, commodities, options or futures are traded.

Forward Price To Earnings (Forward P/E) – A measure of the price-to-earnings ratio (P/E) using forecasted earnings for the P/E calculation. While the earnings used are just an estimate and are not as reliable as current earnings data, there is still benefit in estimated P/E analysis. The forecasted earnings used in the formula can either be for the next 12 months or for the next full-year fiscal period.

Also referred to as “estimated price to earnings”.

The estimated P/E of a company is often used to compare current earnings to estimated future earnings. If earnings are expected to grow in the future, the estimated P/E will be lower than the current P/E. This measure is also used to compare one company to another with a forward-looking focus.

Forward Triangular Merger – A type of merger that occurs when the subsidiary of the acquiring corporation merges with the target firm.

In a forward triangular merger, the subsidiary’s equity merges with the target firm’s stock. As a result of the merger, the target becomes a part of the original subsidiary of the acquirer. This form of acquisition is often used for regulatory reasons.

Globalization – The tendency of investment funds and businesses to move beyond domestic and national markets to other markets around the globe increases the interconnectedness of different markets. Globalization has had the effect of markedly increasing not only international trade, but also cultural exchange;

The advantages and disadvantages of globalization have been heavily scrutinized and debated in recent years. Proponents of globalization say that it helps developing nations “catch up” to industrialized nations much faster through increased employment and technological advances. Critics of globalization say that it weakens national sovereignty and allows rich nations to ship domestic jobs overseas where labor is much cheaper.

Horizontal Merger – A merger occurring between companies producing similar goods or offering similar services. This type of merger occurs frequently as a result of larger companies attempting to create more efficient economies of scale. The amalgamation of Daimler-Benz and Chrysler is a popular example of a horizontal merger.

Hostile Takeover – A takeover attempt that is strongly resisted by the target firm.

Hostile takeovers are usually bad news, as the employee morale of the target firm can quickly turn to animosity against the acquiring firm.

Index – A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is an imaginary portfolio of securities representing a particular market or a portion of it. Each index has its own calculation methodology and is usually expressed in terms of a change from a base value. Thus, the percentage change is more important than the actual numeric value.

Stock and bond market indexes are used to construct index mutual funds and exchange-traded funds (ETFs) whose portfolios mirror the components of the index.

The Standard & Poor’s 500 is one of the world’s best known indexes, and is the most commonly used benchmark for the stock market. Other prominent indexes include the DJ Wilshire 5000 (total stock market), the MSCI EAFE (foreign stocks in Europe, Australia, Far East) and the Lehman Brothers Aggregate Bond Index (total bond market).

Because, technically, you can’t actually invest in an index, index mutual funds and exchange-traded funds (based on indexes) allow investors to invest in securities representing broad market segments and/or the total market.

Initial Public Offering (IPO) – The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking capital to expand, but can also be done by large privately-owned companies looking to become publicly traded.

In an IPO, the issuer obtains the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), best offering price and time to bring it to market.

IPOs can be a risky investment. For the individual investor, it is tough to predict what the stock will do on its initial day of trading and in the near future since there is often little historical data with which to analyze the company. Also, most IPOs are of companies going through a transitory growth period, and they are therefore subject to additional uncertainty regarding their future value.

Also referred to as a “public offering”.

Large Cap (Big Cap) – An abbreviation for the term “large market capitalization”. Market capitalization is calculated by multiplying the number of a company’s shares outstanding by its stock price per share. The expression “large cap” is used by the investment community as an indicator of a company’s size. For example, a large-cap stock would be from a company with a market-capitalization dollar value of over $10 billion.

Large-cap companies are the big ‘kahunas’ of the financial world. Examples include Wal-Mart, Microsoft and General Electric. Stocks such as these are also sometimes called “mega caps”

Keep in mind that the dollar amounts used for the classifications “large cap”, mid cap”, or “small cap” are only approximations that change over time. Among market participants, their exact definitions can vary.

Listed Security – Securities that have been accepted for trading purposes by a recognized and regulated exchange.

Listed securities have the advantage of higher liquidity within a regulated environment. In addition, investors are able to find accurate information on all listed companies.

Market Value –

• The current quoted price at which investors buy or sell a share of common stock or a bond at a given time. Also known as “market price”
• The market capitalization plus the market value of debt. Sometimes referred to as “total market value”.
• In the context of securities, market value is often different from book value because the market takes into account future growth potential. Most investors who use fundamental analysis to pick stocks look at a company’s market value and then determine whether or not the market value is adequate or if it’s undervalued in comparison to it’s book value, net assets or some other measure.

Mega Cap – Companies having a market capitalization greater than $200 billion. These are the big ‘kahunas’ of the financial world. Examples include Wal-Mart, Microsoft and General Electric. Keep in mind that classifications such as “large cap” or “small cap” are only approximations that change over time. Also, the exact definition of these terms can vary between brokerage houses.

Mergers And Acquisitions – A general term used to refer to the consolidation of companies. A merger is a combination of two companies to form a new company. An acquisition is the purchase of one company by another with no new company being formed.

An example of a major merger is the merging of JDS Fitel Inc and Uniphase Corp in 1999 to form JDS Uniphase. An example of a major acquisition is Manulife Financial Corporation’s 2004 acquisition of John Hancock Financial Services Inc.

Micro Cap – Companies with market capitalizations between $50 million and $300 million. A micro-cap stock isn’t the smallest classification – a “nano” cap is even smaller. Keep in mind that classifications such as “large cap” or “small cap” are only approximations that change over time. Also, the exact definition of these terms can vary between brokerage houses.

Merger – The combining of two or more companies, generally by offering the stockholders of one company securities in the acquiring company in exchange for the surrender of their stock. Basically, when two companies become one. This decision is usually mutual between both firms.

Merger Securities – A non-cash asset paid to the shareholders of a corporation that is being acquired or is the target of a merger. These securities generally consist of bonds, options, preferred stock and warrants, among others.

Merger securities can become undervalued when large investment firms are required to sell them as a result of their strict investment requirements. For example, a large mutual fund may receive stock options from an acquiring company when one of the companies held in its portfolio is purchased. If the fund has a policy against holding options, it may be required to sell them, which can then cause the price of the options to fall to very low levels.

Mid Cap – A company with a market capitalization between $2 and $10 billion, which is calculated by multiplying the number of a company’s shares outstanding by its stock price. Mid cap is an abbreviation for the term “middle capitalization”. As the name implies, a mid cap company is in the middle of the pack between large cap and small cap companies. Keep in mind that classifications such as “large cap”, “mid cap” and “small cap” are only approximations that change over time. Also, the exact definition of these terms can vary among the various participants in the investment business.

Monopoly – A situation in which a single company or group owns all or nearly all of the market for a given type of product or service. By definition, monopoly is characterized by an absence of competition – which often results in high prices and inferior products.

For a strict academic definition, a monopoly is a market containing a single firm. Monopoly is the extreme case in capitalism. Most believe that, with few exceptions, the system just doesn’t work when there is only one provider of a good or service because there is no incentive to improve it to meet the demands of consumers. Governments attempt to prevent monopolies from arising through the use of antitrust laws.

Of course, there are gray areas; take for example the granting of patents on new inventions. These give, in effect, a monopoly on a product for a set period of time. The reasoning behind patents is to give innovators some time to recoup what are often large research and development costs. In theory, they are a way of using monopolies to promote innovation. Another example are public monopolies set up by governments to provide essential services. Some believe that utilities should offer public goods and services such as water and electricity at a price affordable to everyone.

Multiple – A term that measures some aspect of a company’s financial well-being, determined by dividing one metric by another metric. The metric in the numerator is typically larger than the one in the denominator, because the top metric is usually supposed to be many times larger than the bottom metric.

For example, the term multiple can be used to show how much investors are willing to pay per dollar of earnings, as computed by the P/E ratio. Suppose you were analyzing a stock with $2 of earnings per share (EPS) that is trading at $20 — this stock would have a P/E of 10. This means investors are willing to pay a multiple of 10 times the current EPS for the stock.

Nano Cap – Small public companies having a market capitalization below $50 million. This is as small as you can get! Nano caps are very risky because they are such small companies. Keep in mind that classifications such as “large cap” or “small cap” are only approximations that change over time. Also, the exact definition of the various sizes of market cap can vary between

Penny Stock – A stock that trades at a relatively low price and market capitalization, usually outside of the major market exchanges. These types of stocks are generally considered to be highly speculative and high risk because of their lack of liquidity, large bid-ask spreads, small capitalization and limited following and disclosure. They will often trade over the counter through the OTCBB and pink sheets.

The term itself is a misnomer because there is no generally accepted definition of a penny stock. Some consider it to be any stock that trades for pennies or those that trade for under $5, while others consider any stock trading off of the major market exchanges as a penny stock. However, confusion can occur as there are some very large companies, based on market capitalization, that trade below $5 per share, while there are many very small companies that trade for $5 or more.

The typical penny stock is a very small company with highly illiquid and speculative shares. The company will also generally be subject to limited listing requirements along with fewer filing and regulatory standards.

Pink Sheets – A daily publication compiled by the National Quotation Bureau with bid and asks prices of over-the-counter stocks, including the market makers who trade them. Unlike companies on a stock exchange, companies quoted on the pink sheets system do not need to meet minimum requirements or file with the SEC. Pink sheets also refers to OTC trading.

The pink sheets got their name because they were actually printed on pink paper. You can tell if a company trades on the pink sheets because the stock symbol will end in “.PK”.

Price-Earnings Ratio (P/E Ratio) – A valuation ratio of a company’s current share price compared to its per-share earnings.

Calculated as:

For example, if a company is currently trading at $43 a share and earnings over the last 12 months were $1.95 per share, the P/E ratio for the stock would be 22.05 ($43/$1.95).

EPS is usually from the last four quarters (trailing P/E), but sometimes it can be taken from the estimates of earnings expected in the next four quarters (projected or forward P/E). A third variation uses the sum of the last two actual quarters and the estimates of the next two quarters.

Also sometimes known as “price multiple” or “earnings multiple”.

In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. However, the P/E ratio doesn’t tell us the whole story by itself. It’s usually more useful to compare the P/E ratios of one company to other companies in the same industry, to the market in general or against the company’s own historical P/E. It would not be useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a technology company (high P/E) to a utility company (low P/E) as each industry has much different growth prospects.

The P/E is sometimes referred to as the “multiple”, because it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings.

It is important that investors note an important problem that arises with the P/E measure, and to avoid basing a decision on this measure alone. The denominator (earnings) is based on an accounting measure of earnings that is susceptible to forms of manipulation, making the quality of the P/E only as good as the quality of the underlying earnings number.

A lower P/B ratio could mean that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company. As with most ratios, be aware this varies by industry.

This ratio also gives some idea of whether you’re paying too much for what would be left if the company went bankrupt immediately.

Price/Earnings To Growth (PEG Ratio) – A ratio used to determine a stock’s value while taking into account earnings growth. The calculation is as follows:

PEG is a widely used indicator of a stock’s potential value. It is favored by many over the price/earnings ratio because it also accounts for growth. Similar to the P/E ratio, a lower PEG means that the stock is more undervalued.

Keep in mind that the numbers used are projected and, therefore, can be less accurate. Also, there are many variations using earnings from different time periods (i.e. one year vs. five year). Be sure to know the exact definition your source is using.

Price-To-Sales Ratio (Price/Sales) – A ratio for valuing a stock relative to its own past performance, other companies or the market itself. Price to sales is calculated by dividing a stock’s current price by its revenue per share for the trailing 12 months:

The ratio can also be referred to as a stock’s “PSR”. The price-to-sales ratio can vary substantially across industries; therefore, it’s useful mainly when comparing similar companies. Because it doesn’t take any expenses or debt into account, the ratio is somewhat limited in the story it tells.

Price-Earnings Relative – A price-earnings ratio of a stock divided by the price-earnings ratio of a market measure, or index, such as the S&P 500 or Wilshire 5000.

This is a method for judging whether a price-earnings ratio is reasonable in relation to market conditions and historical P/Es.

Price-To-Book Ratio (P/B Ratio) – A ratio used to compare a stock’s market value to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter’s book value per share.

Also known as the “price-equity ratio”.

Poison Pill – A strategy used by corporations to discourage a hostile takeover by another company. The target company attempts to make its stock less attractive to the acquirer. There are two types of poison pills:

• A “flip-in” allows existing shareholders (except the acquirer) to buy more shares at a discount.
• The “flip-over” allows a stockholder to buy the acquirer’s shares at a discounted price after the merger.
  • By purchasing more shares cheaply (flip-in), investors get instant profits and, more importantly, they dilute the shares held by the competitors. As a result, the competitor’s takeover attempt is made more difficult and expensive.
  • An example of a flip-over is when shareholders have the right to purchase stock of the acquirer on a 2-for-1 basis in any subsequent merger.
  • This is similar to the macaroni defense, except it uses equity rather than bonds.

Premium – The total cost of an option.

• The difference between the higher price paid for a fixed-income security and the security’s face amount at issue.
• The specified amount of payment required periodically by an insurer to provide coverage under a given insurance plan for a defined period of time. The premium is paid by the insured party to the insurer, and primarily compensates the insurer for bearing the risk of a payout should the insurance agreement’s coverage be required.

• The premium of an option is basically the sum of the option’s intrinsic and time value. It is important to note that volatility also affects the premium.
• If a fixed-income security (bond) is purchased at a premium, existing interest rates are lower than the coupon rate. Investors pay a premium for an investment that will return an amount greater than existing interest rates.

Private Company – A company whose ownership is private. As a result, it does not need to meet the strict Securities and Exchange Commission filing requirements of public companies.

Private companies may issue stock and have shareholders. However, their shares do not trade on public exchanges and are not issued through an initial public offering. In general, the shares of these businesses are less liquid and the values are difficult to determine.

Public Company – A company that has issued securities through an initial public offering and which are traded on at least one stock exchange or over-the-counter market.

These companies must file documents and meet stringent reporting requirements set out by the Securities and Exchange Commission, including the public disclosure of financial statements. Any company whose shares are available to the public is a public company.

Raider – An individual or organization who tries to take over a company by initiating a hostile takeover bid. Raiders look for companies with undervalued assets and then attempt the hostile takeover by purchasing enough shares to have a controlling interest.

Research And Development (R&D) – Investigative activities that a business chooses to conduct with the intention of making a discovery that can either lead to the development of new products or procedures, or to improvement of existing products or procedures. Research and development is one of the means by which business can experience future growth by developing new products or processes to improve and expand their operations.

While R&D is often thought of as synonymous with high-tech firms that are on the cutting edge of new technology, many established consumer goods companies spend large sums of money on improving old products. For example, Gillette spends quite a bit on R&D each year in ongoing attempts to design a more effective shaver.

On average, most companies spend only a small percentage of their revenue on R&D (usually under 5%). However, pharmaceuticals, software and semiconductor companies tend to spend quite a bit more.

Replacement Cost – The price that will have to be paid to replace an existing asset with a similar asset. This is relevant because the replacement cost will most likely be different than fair market value or net realizable value.

Reverse Takeover (RTO) – A type of merger used by private companies to become publicly traded without resorting to an initial public offering. Initially, the private company buys enough shares to control a publicly traded company. At this point, the private company’s shareholder uses their shares in the private company to exchange for shares in the public company. At this point, the private company has effectively become a publicly traded one.

With this type of merger, the private company does not need to pay the expensive fees associated with arranging an initial public offering. The problem, however, is the company does not acquired any additional funds through the merger and it must have enough funds to complete the transaction on its own.

A reverse takeover can also refer to situation where a smaller company acquires a larger company.

Reverse Triangular Merger – When the subsidiary of the acquiring corporation merges with the target firm. In this case, the subsidiary’s equity merges with the target firm’s stock. As a result of the merger, the target would become a wholly-owned subsidiary of the acquirer and shareholders of the target would get shares of the acquirer. This form of acquisition is often used for regulatory reasons.

Outstanding Shares – Stock currently held by investors, including restricted shares owned by the company’s officers and insiders, as well as those held by the public. Shares that have been repurchased by the company are not considered outstanding stock.

This number is shown on a company’s balance sheet under the heading “Capital Stock” and is more important than the authorized shares or float. It is used to calculate many metrics, including market capitalization and earnings per share (EPS).

Sweetheart Deal – A merger, a sale or an agreement in which one party in the deal presents the other party with very attractive terms and conditions. The terms of a sweetheart deal are usually so lucrative that it is difficult to justify turning the offer down.

This term can be used to describe a variety of deals, but in general, a sweetheart deal is a transaction that simply can’t be passed up. For example, a merger may be a sweetheart deal for the top executives of the target firm because they get very healthy buyout packages. This kind of sweetheart deal is usually considered unethical, however, because it may not be in the best interests of shareholders.

Synergy – The idea that the value and performance of two companies combined will be greater than the sum of the separate individual parts. This term is used mostly in the context of mergers and acquisitions. For example, if Company A has an excellent product but lousy distribution whereas Company B has a great distribution system but poor products, the companies could create synergy with a merger.

Stock-For-Stock –

• In the context of mergers and acquisitions, the exchange of an acquiring company’s stock for the stock of the acquired company at a predetermined rate. Usually, only a portion of a merger is completed with a stock-for-stock transaction, with the rest of the expenses being covered with cash or other payment methods.
• A method of satisfying the option price in an employee stock option compensation scheme. Under these compensation programs, employees are granted stock options but must pay the company the option price before they are given the grant. By exchanging mature stock (stock that has been held for a required holding period), the grantee can receive his/her options without having to pay for them. After a given time period, grantees are given back the stock they used to pay for their options.For example, in order to satisfy the expenses of an acquisition, an acquiring company may use a combination of 2 for 3 stock-for-stock exchange with shareholders of the target company and a tender offer of cash.
• Where possible, grantees often take advantage of a stock-for-stock exchange, as they usually increase a grantee’s ownership position and require no cash outlay. Non-employee shareholders argue that stock-for-stock option price satisfaction adds to the already high expense of granting employees options, as the employees end up not having to pay the option price, which can add up to be a significant amount of cash if all employees granted options take advantage of stock-for-stock exercises.

Stock Dividend – A dividend payment made in the form of additional shares, rather than a cash payout. Companies may decide to distribute stock to shareholders of record if the company’s availability of liquid cash is in short supply. These distributions are generally acknowledged in the form of fractions paid per existing share. An example would be a company issuing a stock dividend of 0.05 shares for each single share held.

Also known as a “scrip dividend.”

Secondary Stock – A stock that is considered riskier than blue chips because it has a smaller market capitalization.

This is another term for “small cap.”

Security – An instrument representing ownership (stocks), a debt agreement (bonds), or the rights to ownership (derivatives). A security is essentially a contract that can be assigned a value and traded. Examples of a security include a note, stock, preferred share, bond, debenture, option, future, swap, right, warrant, or virtually any other financial asset.

Securities And Exchange Commission (SEC) – A government commission created by Congress to regulate the securities markets and protects investors. In addition to regulation and protection, it also monitors the corporate takeovers in the U.S. The SEC is composed of five commissioners appointed by the U.S. President and approved by the Senate. The statutes administered by the SEC are designed to promote full public disclosure and to protect the investing public against fraudulent and manipulative practices in the securities markets. Generally, most issues of securities offered in interstate commerce, through the mail or on the internet, must be registered with the SEC.

Shareholder – Any person, company, or other institution that owns at least 1 share in a company. A shareholder may also be referred to as a stockholder. Shareholders are the owners of a company. They have the potential to profit if the company does well, but that comes with the potential to lose if the company does poorly.

Small Cap – Refers to stocks with a relatively small market capitalization. The definition of small cap can vary among brokerages, but generally it is a company with a market capitalization of between $300 million and $2 billion.

One of the biggest advantages of investing in small-cap stocks is the opportunity to beat institutional investors. Because mutual funds have restrictions that limit them from buying large portions of any one issuer’s outstanding shares, some mutual funds would not be able to give the small cap a meaningful position in the fund. To overcome these limitations, the fund would usually have to file with the SEC, which means tipping its hand and inflating the previously attractive price. Keep in mind that classifications such as “large cap” or “small cap” are only approximations that change over time. Also, the exact definition can vary between brokerage houses.

Stock – type of security that signifies ownership in a corporation and represents a claim on part of the corporation’s assets and earnings.

There are two main types of stock: common and preferred. Common stock usually entitles the owner to vote at shareholders’ meetings and to receive dividends. Preferred stock generally does not have voting rights, but has a higher claim on assets and earnings than the common shares. For example, owners of preferred stock receive dividends before common shareholders and have priority in the event that a company goes bankrupt and is liquidated.

Also known as “shares” or “equity”.

A holder of stock (a shareholder) has a claim to a part of the corporation’s assets and earnings. In other words, a shareholder is an owner of a company. Ownership is determined by the number of shares a person owns relative to the number of outstanding shares. For example, if a company has 1,000 shares of stock outstanding and one person owns 100 shares, that person would own and have claim to 10% of the company’s assets. Stocks are the foundation of nearly every portfolio. Historically, they have outperformed most other investments over the long run.

Tender Offer – An offer to purchase some or all of shareholders’ shares in a corporation. The price offered is usually at a premium to the market price.

Tender offers may be friendly or unfriendly. Securities and Exchange Commission laws require any corporation or individual acquiring 5% of a company to disclose information to the SEC, the target company and the exchange.

Trailing Price-To-Earnings (Trailing P/E) – The sum of a company’s price-to-earnings, calculated by taking the current stock price and dividing it by the trailing earnings per share for the past 12 months. This measure differs from forward P/E, which uses earnings estimates for the next four quarters.

This is the most commonly used P/E measure because it is based on actual earnings and, therefore, is the most accurate. However, stock prices are constantly moving while earnings remain fixed. As a result, forward P/E can sometimes be more relevant to investors when evaluating a company.

Target Firm – A firm that has been targeted by another firm for a takeover.

Companies are targeted for a number of reasons. A firm may be attractive because it possesses large cash reserves, undervalued real estate or otherwise huge potential.

Tracking Stock –

• Common stock issued by a parent company that tracks the performance of a particular division without having claim on the assets of the division or the parent company.
• A type of security specifically designed to mirror the performance of a larger index.
• When a parent company issues a tracking stock, all revenues and expenses of the applicable division are separated from the parent company’s financial statements and bound to the tracking stock. Oftentimes, this is done to separate a subsidiary’s high-growth division from a larger parent company that is presenting losses. The parent company and its shareholders, however, still control the operations of the subsidiary.
• The most popular tracking stock is the QQQQ, which is an exchange-traded fund that mirrors the returns of the Nasdaq 100 index. Another type of tracking stock is Standard & Poor’s depository receipts (SPDRs), which mirror the returns of the S&P 500 index.

Undervalued – A stock or other security that is trading below its true value. The difficulty is determining what the “true” value actually is. Analysts will usually recommend an undervalued stock with a strong buy rating.

Vertical Merger – A merger between two companies producing different goods or services for one specific finished product. By directly merging with suppliers, a company can decrease reliance and increase profitability. An example of a vertical merger is a car manufacturer purchasing a tire company.

Whitewash Resolution – A European term used in conjunction with the Companies Act Of 1985, which refers to a resolution that must be passed before a target company in a buyout situation can give financial assistance, forgive debts or provide other financial dealings to the buyer of the acquiring entity. A whitewash resolution occurs when directors of the target company must swear that the company will be able to pay its debts for a period of at least 12 months. Oftentimes, an auditor must then confirm the company’s solvency. Only after this takes place may a target company give the purchasing company any type of financial assistance. Some companies have used acquisitions as a means of obtaining financing and draining the assets of the target companies only to leave those companies debt ridden and unable to pay their bills. The Companies Act Of 1985 and the whitewash resolution is meant to ensure that the target company will remain solvent and will not seek to discharge its liabilities once the acquisition is complete.

White Knight – A company that makes a friendly takeover offer to a target company that is being faced with a hostile takeover from a separate party.