Financial glossary
for new-age investors

Discover financial terms and learn new concepts.

Net Debt To EBITDA Ratio

Net debt to EBITDA is a ratio that measures a company’s “leverage”. More specifically, how easily it can pay off its debts. The metric compares a company’s outstanding interest-bearing liabilities in the form of net debt to its annual cash flow as measured by EBITDA (earnings before interest, taxes, depreciation, and amortization), and tells you in theory how many years it would take for a company to pay off its debts if its cash flow remains constant. A lower net debt to EBITDA ratio indicates a company can more quickly pay off its debts from the money it earns through its operations, suggesting financial stability. Conversely, a higher ratio indicates a company that could struggle to meet its debt obligations if its earnings don’t grow.

Operating Leverage

Operating leverage reflects the proportion of fixed costs to variable costs in a company's structure, indicating how changes in sales volume affect operating income. High operating leverage suggests a company has significant fixed costs relative to its variable costs, making earnings highly sensitive to fluctuations in sales. This means small changes in sales can lead to more pronounced swings in operating income. Operating leverage is particularly insightful for gauging a company’s profitability dynamics and its vulnerability to sales volume changes, pivotal in industries with significant upfront investments like manufacturing or software development.

Operating Profit Margin

An operating profit margin – a.k.a. an operating or earnings before income and tax (EBIT) margin – is a key profitability ratio. It shows, for a given period, what proportion of every dollar worth of sales a company makes is left over as profit after costs related to directly operating the company are paid (e.g. production of goods, staff costs, marketing). A higher profit margin is better.

Options

Just as it sounds, an option gives its holder the right (but not the obligation) to conduct a transaction. Options typically exist to buy or sell a stock (or other security) at a certain price. If an investor holds an option to buy a stock for less than its current price, or to sell a stock for more than its current price, then that option is said to be “in the money”. Options are derivatives – their value primarily comes from the value of the thing that the option is on (e.g. the price of the stock in question). However, things like the length of time that the option lasts for (e.g. one month, three months, or one year) and the probability of the “underlying investment” (in this case, the stock price) achieving the option price also have an impact on the option’s value. And while option values are related to the price of the underlying investments, the options themselves have their own value.

Peer-To-Peer Lending

A new-ish online business model that matches borrowers and lenders. In theory, because these companies operate with less overheard (i.e. they are online only and are generally less regulated than a typical bank), they have lower cost and can provide lending services at lower rates than traditional banks. However, after a few years of popularity, the business model appears to increasingly struggle to differentiate itself from more traditional lenders.

Penny Stocks

Penny stocks represent the more adventurous side of the stock market. Typically in the US, these are shares of small companies that trade for less than $5 each. Known for their volatility and high risk, penny stocks attract investors looking for significant growth potential at a low buy-in cost. Despite their name, penny stocks aren’t just about the price: to qualify, stocks need to have both a low overall market capitalization and a low nominal share price. Large-cap companies with a lot of shares in circulation can have a low share price (and indeed, some of the biggest companies routinely split their shares to reduce the price of a single one) but are not penny stocks.

Price-To-Earnings (P/E) Ratio

The price-to-earnings (P/E) ratio measures the value of a company’s stock versus its annual profit (technically, it’s a company’s share price vs its annual earnings per share). A lower P/E ratio indicates a cheaper stock and a higher P/E ratio indicates a more expensive stock. Companies that are “richly” valued are worth a lot relative to their profits – that’s usually because their profits are expected to increase quickly in the future and, therefore, investors are paying up for access to those future profits. Stocks with “cheap” valuations are usually mature or struggling companies, i.e. they are unlikely to exhibit much profit growth (although this doesn’t necessarily mean they are bad investments).

Private Equity

Private equity is the stock of a company that is not a “public” company and therefore whose shares are not freely traded on a stock market. The place where you get your haircut is probably a “private” company (albeit a very small one). A private equity firm is an investment firm that invests in such companies (usually quite large private companies).

Productivity

It measures how efficient it is to produce goods and/or services in an economy. Technically, that means how many inputs (like workers or machinery) it takes to get a certain amount of output. The fewer inputs that are required for a set amount of output, the higher the productivity. Companies try to boost productivity because if they can produce more output with the same inputs than their costs go down – and their profits go up. From the perspective of the overall economy, high productivity is usually a good sign – it shows that innovation is occurring (i.e. improved technology is typically necessary for productivity to improve). And generally speaking, innovation leads to higher standards of living for the overall population (for example, better healthcare productivity = longer lifespans).