Basic Terms for Beginners in U.S. Stocks

You’ve decided to start investing in U.S. stocks and just opened an account—now, which stock should you buy?

The stocks people always talk about? The Starbucks you visit all the time? Apple, whose logo you see everywhere on the street?

Nothing really comes to mind, so after mulling it over, you end up typing the following into a search engine: “U.S. stock recommendations”

You weren’t necessarily looking for hard recommendations; you just thought that if you browsed through different opinions, something might catch your eye.

Then you start wondering what the experts think. Lying on the sofa on a day off, scrolling on your phone, you come across a consensus that aggregates expert opinions.

Wait a second!

You shouldn’t rush into a decision based on this alone.

This is a Chosun Biz news article explaining that most investment recommendations from domestic brokerages are “Buy” ratings.

Some of you may have invested based solely on consensus recommendations and then endured long, painful days of waiting.

Clearly, it’s important that we check things with our own eyes.

If a company is a pizza, its shares are the toppings. Depending on how many there are, one slice can be divided up.

For a stock to rise over the long term, the company needs to be well managed and generate solid profits.

This is where financial metrics come in. By looking at them, we can tell whether a company is doing well and understand its current situation.

Even if you know all kinds of metrics, they are useless if you don’t know where to look them up.

So we should know where these metrics are collected and displayed, right?

On Naver Finance, if you select the company you want to analyze and then go to Domestic/Overseas → Financials → Key Financials or Financial Ratios, you’ll see a list of cryptic abbreviations and numbers.

Besides Naver Finance, there are other websites where you can check these metrics, such as Yahoo Finance and Investing.com. But we’ll stop the introductions here and, for today, walk through everything using Naver Finance as our reference.

PER (Price Earnings Ratio) refers to the price-to-earnings ratio.

In Western markets, PER is often written as P/E. It is calculated by dividing the share price by earnings per share and shows how much profit is generated per share.

When the PER is low, it means the share price is low relative to the company’s earnings, so the stock can be seen as undervalued compared with the company’s intrinsic value. Conversely, when the PER is high, the share price can be interpreted as being overvalued relative to the earnings it generates.

However, a high PER does not automatically mean the stock is overvalued.

Take AI companies, for example: they often require heavy upfront R&D spending, so even if they have strong potential to generate large profits in the future, their current earnings can be small. On the other hand, in industries like manufacturing, which are far removed from expectations about future growth like tech-driven sectors, a low PER can be seen as a positive. Even in manufacturing, however, a temporary spike in earnings can push the PER down. It is better to check whether the PER stays low consistently over time.

PBR (Price to Book Ratio) refers to the price-to-book ratio.

It is calculated by dividing the share price by book value per share, and shows how the stock price is valued relative to the company’s net assets.

When the PBR is low, it means the company’s share price is undervalued relative to its net assets. Conversely, when the PBR is high, it indicates the share price is overvalued compared with its net assets.

As with PER, a low PBR does not necessarily mean the stock is undervalued.

For example, if the quality of assets is poor or the company holds a large amount of non-core assets, the share price may not rise even when the PBR is low.

High-quality assets are those that can be easily converted into cash. In contrast, outdated facilities and equipment or idle inventories are low-quality assets: they may carry high book values, but their actual economic value can be much lower.

Non-core assets are assets that are not related to a company’s main line of business. For instance, even if a financial company owns equity stakes in a manufacturing firm, those stakes may have little impact on the financial company’s profitability. Likewise, a manufacturing company that owns a commercial building is holding an asset that is unrelated to its core manufacturing operations.

PCR (Price to Cash Flow Ratio) refers to the price-to-cash-flow ratio.

PCR is calculated by dividing the share price by cash flow per share, and it indicates how highly the stock is valued relative to its cash flow.

When the PCR is low, it means the company’s stock is undervalued relative to its cash flow, and when the PCR is high, it means the stock is overvalued relative to its cash flow.

There are also caveats when using PCR.

One case is when a company’s cash flow has temporarily surged or is highly volatile. This may have little to do with the firm’s long-term profitability.

Examples of temporarily higher cash flow include selling assets such as land or real estate, receiving grants for research and development, or winning a lawsuit and collecting settlement payments. No company can make money forever just by selling off assets, living on research grants, or relying solely on lawsuits.

Similarly, cash flow may spike after receiving a large one-off order from a particular customer, due to seasonal factors, or because a drop in raw material prices has reduced production costs. But there is no guarantee that the customer will place large orders every day, that summer will last all year, or that lower raw material prices will not rise again.

For companies whose cash flows are inconsistent or highly volatile, the PCR can therefore be less reliable.

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) refers to earnings before interest and taxes, plus depreciation and amortization.

EBITDA represents the cash a company generates and is useful for assessing its cash-generating ability.

We invest on the premise that companies which generate a lot of cash are good businesses and good stocks. However, items such as depreciation and amortization do not involve actual cash outflows. In the case of PER, depreciation and amortization—which do not entail real cash going out—are reflected, so the metric can be distorted depending on accounting treatment. For this reason, EBITDA, which adds back depreciation and amortization, can be more appropriate for evaluating a company’s cash-generating capacity.

However, when depreciation and amortization are a major factor, EBITDA can be misleading.

We might unconsciously assume that depreciation always happens slowly, but when technology advances rapidly, periodic replacement or upgrades are needed, which can shorten the useful life of equipment. IT hardware, medical devices, software, and telecommunications equipment that require up-to-date technology and high accuracy fall into this category.

EV/EBITDA (Enterprise Value to EBITDA) represents the ratio of enterprise value to EBITDA.

By calculating EV/EBITDA, you can see how many years it would take to recoup your initial investment based on the company’s cash-generating ability. For this reason, it is frequently used when valuing companies that require large upfront investments, particularly in the M&A market.

A low EV/EBITDA suggests that the company is undervalued relative to its cash-generating capacity, while a high EV/EBITDA can be interpreted as the company being overvalued.

However, remember that the EBITDA used in EV/EBITDA is calculated after adding back the debt service burden that the company must ultimately bear.

Because of this, it can be difficult to apply this metric to companies with excessive leverage or deteriorating financial soundness.

EPS (Earnings Per Share) stands for earnings per share.

In other words, it indicates how much profit is generated per share.

The higher the EPS, the greater the profit returned to shareholders, which is why shareholders often use it when assessing a company’s value.

Because EPS uses the number of shares outstanding, there is an important caveat to keep in mind.

EPS is affected by changes in the number of shares outstanding, so it can fluctuate due to stock splits, share buybacks, and similar events. If a company has recently conducted a share buyback, it is not appropriate to assess its value based on EPS.

BPS (Book Value Per Share) refers to book value per share.

This is an indicator that shows how much net asset value is attributable to each share. In general, the higher the BPS, the healthier the company’s financial structure.

BPS shares the same caveats as PBR.

That is because BPS is the denominator in PBR.

If the quality of a company’s assets is low or it holds a large amount of non-core assets, BPS can be misleading. You also need to take into account temporary fluctuations caused by asset sales or differences in valuation methods.

DPS (Dividend Per Share) refers to dividends per share.

It is an indicator that shows the amount of dividend paid per share.

The higher the DPS, the greater the cash flow returned to shareholders. It is a metric that tends to appeal to investors interested in dividend stocks.

However, dividends are not always a good thing, and the same goes for DPS.

Remember that the more a company pays dividends to shareholders, the less cash it retains. As the remaining cash shrinks, its capacity for reinvestment naturally declines, which can undermine its growth potential.

CAPEX (Capital Expenditure) refers to capital expenditures.

Capital expenditures are outlays a company incurs to maintain or newly acquire fixed assets. The higher the CAPEX, the more the company is investing to drive future growth.

Since CAPEX is, in the end, an expenditure, excessive CAPEX can negatively affect cash flows and the company’s financial structure. These outlays only become meaningful if they can ultimately translate into earnings.

FCF (Free Cash Flow) refers to free cash flow.

It is the amount you get by subtracting CAPEX, which we just learned about, from the cash generated by operating activities. Literally, it is the surplus—the cash left over for the company. The higher the FCF, the more cash the company has available to use at its discretion.

We want the goose that lays the golden eggs, not the golden eggs themselves.

A large amount of excess cash implies a low likelihood that the company’s financial health will deteriorate, but how that excess cash is used is something you need to watch. Even if FCF is high, if a company’s future investment plans are weak, its growth potential may not be proportional to that cash.

*Operating cash flow is sometimes called CFO (Cash Flow from Operations), but in financial analysis the term OCF (Operating Cash Flow) is more commonly used. It refers to operating cash flow excluding cash flows from non-operating activities such as interest expenses and investments.

ROE (Return on Equity) stands for return on equity.

It is the ratio of net income to shareholders’ equity, and indicates the return generated on the capital invested by shareholders.

The higher the ROE, the more profit is being returned to shareholders; conversely, a low ROE can be interpreted as the company using shareholders’ capital inefficiently.

The equity used in ROE is net assets, which exclude liabilities.

In other words, when a company boosts net income by piling on debt, it is not appropriate to evaluate it based solely on ROE. ROE may look good for a while, but the financial risk created by excessive leverage can make it difficult to sustain that ROE over time.

ROA (Return on Assets) stands for return on assets.

It is the ratio of net income to total assets and indicates how efficiently a company is using its assets.

The higher the ROA, the more efficiently the company is using its assets to generate profits.

You should also be cautious about temporary increases in ROA driven by asset sales, and be aware that ROA can vary depending on how assets are measured and valued.

Lastly, because capital structures and profitability differ by industry, these metrics are best used to compare companies within the same industry.

AWARE will always be here to support your healthy investing journey.