What's a benchmark? Or buyback? Or moat?

Readers said they were unclear on what certain financial jargon means, so we're providing a few more definitions.

Adam Zoll 9 March, 2015 | 5:00PM
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recent Ask the Expert column explained some commonly used but occasionally misunderstood financial jargon, and at the end we asked users to submit their own nominations for the list. We received lots of great suggestions, and this week we take on some of these reader-submitted items. So here we go:

Annual dividend/yield: The amount of a security's income that is distributed to its shareholders during the course of a year. Some stocks pay shareholders a portion of company profits in the form of dividends while bond holders typically receive interest payments. Both may be referred to as the investment's yield. (On Morningstar.ca's mutual fund and exchange-traded fund quote pages, this is represented by the "TTM Yield" metric, which stands for trailing 12-month yield. A 30-day SEC yield is also included for U.S.-traded ETFs. Yields at the top of stock quote pages also are TTM.) To calculate a security's annual yield, simply divide the amount of income paid out to investors during the past year by its share price.

Asset class: A broadly defined group of assets that have similar characteristics. Often these classes are broken down into stocks, bonds, cash and commodities, but the term could also be used to refer to non-securitized assets such as real estate and collectibles (such as fine art or rare coins).

Benchmark: Quite simply, a yardstick used to measure the performance of a security. For example, the S&P/TSX Composite Index, which tracks about 260 of the largest Canadian companies, is commonly used as a benchmark with which to compare the performances of Canadian-equity mutual funds. Other indexes, such as the S&P 500 Index, which tracks 500 of the largest U.S. companies, and the BMO Small Cap Index, which tracks Canadian small-cap stocks, are used as benchmarks for U.S. Equity and domestic small-cap funds, respectively. Other uses for benchmarks include assessing a fund's allocation relative to an index. A fund's management team may also establish its own internal benchmarks, for example as a way to hew to self-imposed allocation guidelines.

Buyback: When a company uses cash to buy back shares of its stock. This may be done as a way to return value to shareholders (because buying back shares reduces the number outstanding, meaning that existing shareholders own a larger share of the business). Buybacks often occur when company management believes its shares are underpriced and expects them to rise in value, or when the company seeks to offset the impact of stock options and stock grants.

Cyclical stock: The stock of a company whose performance tends to rise and fall depending on the economic environment. For example, a maker of luxury goods might see its biggest profits when the economy is booming -- meaning that more people can afford its products -- but experience reduced profits or even losses during times of economic distress. Examples of consumer cyclical stocks include:  Home Depot HD Las Vegas Sands LVS McDonald's MCD and  Daimler DDAIY.

Defensive stock: The stock of a company whose performance is less sensitive than most to the ups and downs of the economy because it sells products and services that people need to buy no matter what. This includes many consumer staples, health-care and utilities stocks.

Exchange: A marketplace where securities are traded, such as the Toronto Stock Exchange (part of TMX Group X) or Nasdaq (part of  NASDAQ OMX Group NDAQ). Many major financial centers around the world have their own exchanges, including Hong Kong, London, Shanghai and Tokyo, where domestic or regional shares are traded. Exchanges may be physical trading spaces (TSX) or virtual ones that exist only in cyberspace (Nasdaq).

Fundamentals: In investing parlance, this refers to a company's performance as measured by core statistics such as revenue, net income and cash flow as opposed to non-fundamental factors such as the performance of its stock price.

Economic moat: Coined by Warren Buffett and widely used by Morningstar, this term refers to a company's sustainable competitive advantages over its competitors. This can be achieved in one of five ways: cost advantage, efficient scale, intangible assets, network effect or switching costs. Morningstar assigns its Economic Moat Rating (wide, narrow or no moat) to all the companies its equity analysts cover. Morningstar research has shown that companies with wide moats tend to be better at sustaining profitability over time than those with narrow or no moats.

Real return: An asset's return after accounting for inflation. For example, a fund that returns 10% in a given year in which inflation runs at 2% has a real return of 8%.

Sector: A segment of the economy, used to classify stocks. Morningstar groups stocks into the following sectors: basic materials, communication services, consumer cyclical, consumer defensive, energy, financial services, health care, industrials, real estate, utilities and technology. A fund whose portfolio is more heavily allocated to a given sector than its benchmark may be said to have a sector bias.

Security: A financial instrument representing ownership of an asset (as with stocks) or debt owed (as with bonds). Other examples include mutual funds, ETFs, futures, options and swaps.

Share class: Type of fund share, typically differentiated by its distribution channel and/or fees charged. Retail or investor share classes may be purchased directly from fund companies or brokerages by individual investors. Advisor share classes are sold through financial advisors, and institutional share classes are offered through institutions, including pension plans. For many years the naming convention for share classes in Canada was a free-for-all, with no real consistency from one fund company to another, but last summer the Canadian Investment Funds Standards Committee (CIFSC) devised a way to categorize these share classes. You can read about it here.  Some stocks also have different share classes, as explained in this Ask the Expert column.

Underweight/overweight: Refers to whether a fund's allocation to a given type of asset is greater than (overweight) or less than (underweight) that of its benchmark. For example, a Canadian Equity fund that holds 15% of assets in financial-services stocks may be said to be underweight in that sector relative to a benchmark such as the S&P/TSX Composite.

Are there additional investing terms that you've wondered about and that aren't included here? Email them to us for possible use in a future article.

Have a personal finance question you'd like answered? Send it to AskTheExpert@morningstar.com.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Las Vegas Sands Corp46.16 USD1.94Rating
McDonald's Corp263.64 USD-1.52Rating
Nasdaq Inc48.33 USD0.73Rating
The Home Depot Inc301.82 USD-0.24Rating
TMX Group Ltd28.59 CAD0.00

About Author

Adam Zoll

Adam Zoll  Adam Zoll is an assistant site editor with Morningstar.com

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