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What It Really Means to Be Long or Short

February 7, 2017 / Investing, Stocks

“Buy Low Sell High” by Conner W. Mays – Being “Long” or “ Short ” a stock simply refers to the side of the trade your money is on.

When an investor or trader is “Long” it means they have a position that they will profit from if the price of the security increases, when you purchase a security, you are “Long” the security.

When an investor or trader is “ Short ” is means they have a position that they will profit from if the price of the security decreases. This may seem counterintuitive but it is pretty simple from a conceptual standpoint. If you think a security is going to decrease in value, you can put on a “ Short ” position by essentially “borrowing” the security from someone that owns it and then you can sell it in the market. Which means you are selling a security that you don’t actually own. If the security declines in value as you thought, you buy it back and return it to the owner and you keep the difference as your profit. However, if the security increases in value, the owner of the security could ask for their shares back (aka ask you to cover your short position), which requires you to buy the securities back at a higher price, and you will lose money on the trade.

Earnings

Earnings refer to the amount of money a company earned over a specified time period, usually quoted in term of Earnings-Per-Share (EPS.)

Earnings, in their purest form, are pretty straight forward, however if you happen to turn on CNBC around the end of a quarter, you will hear a lot of language around earnings that can make earnings a bit more difficult to understand.

Adjusted Earnings

Adjusted earnings are exactly what you might expect given the term. It is the company’s earnings adjusted for items that are not expected to repeat in the future or revenues/charges that are not considered to be part of the company’s “Business-As-Usual.” Adjusted earnings can come in a variety of forms, the important thing here is to realize that when you see “Adj. EPS” it means that the company has adjusted the figure.

Top Line vs. Bottom Line

If I was trying to be a 100% purist – I would say the “Top Line” is not earnings. However, the “Top Line” refers to the amount of income a company brought in, also referred to as Revenue or Sales. The number is measured prior to any expenses or other charges. The “Bottom Line” is the area the unadjusted EPS is sourced from.

Why are earnings so important?
“In the short term, the market is a voting machine. In the long term, it is a scale of value.”  – Benjamin Graham

The most important piece of weight in the scale of value Benjamin Graham is referring to is a company’s earning potential, hence earnings are considered one of the most important indicators and drivers of stock price appreciation. Equity Research Analysts publish their forecasts (very educated guesses) for a company’s earnings, the average of these estimates id referred to as “consensus” or what the collective guess of the amount of money the company will earn. Consensus estimates are very important, 99.9% of the time if you see and EPS number on CNBC it will be quickly followed by “vs. consensus EPS.” When a company earns more than the consensus estimate (beats consensus / beats the street) the price of their stocks tend to increase, except in a few special cases. Conversely, when a company’s EPS comes in below consensus estimates, the value of the company’s equity generally declines.

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