Accounting - Investor ratios

Question 1

What are the investor ratios?

Answer 1

1) EPS
2) Diluted EPS
3) Earnings Yield
4) Div Yield
5) Div Cover
6) P/E

Question 2

What is EPS?

Answer 2

EPS = Earnings from ord shareholders / no of ord shares

if needed earnings from ord = Net income - preference div

Question 3

What does EPS allow investors to do?

Answer 3

Compare company profitability - most useful and popular ratio

Question 4

What defines EPS and rules for Calculation?

Answer 4

IAS33

Question 5

What is Diluted EPS?

Answer 5

• Theoretical
• based on potential scenario
• Disclosure required by IAS33

Question 6

What is purpose of EPS?

Answer 6

warn SH of potential further changed in EPS figure as a result of actions which make take place

Question 7

What type of accounting should be followed? Prudent or not?

Answer 7

Prudent - we should assume the worst case scenario

Question 8

What 4 factors lead to share dilution?

Answer 8

1) Convertible loan stock / preference shares
2) Options / Warrants
3) Employee stock options
4) new shares issued

Question 9

Which should be larger Basic EPS or Diluted?

Answer 9

Basic EPS

if not then use basic anyway

Question 10

Earnings Yield ratio?

Answer 10

EY = EPS / Market share price

Question 11

Interpretation of EY?

Answer 11

If industry sector is 10% and yield is 7% - shares are in relatively high demand - maybe because rapid growth is expected and investors are discouting by buying shares

High EY e.g 16% - may mean company not in favour with investors who may anticipate poor yield and weakness

Question 12

What should EY be compared too?

Answer 12

investors compare EY of index (e.g FTSE 100) to prevailing interest rates (e.g yield on 10 yr gilts) to measure the equity risk premium

Question 13

What is Div Yield calc?

Answer 13

DY = Div/share / Price/Share

Question 14

Interpretation of Div Yield

Answer 14

Low DY = may indicate high future growth
High DY = could mean a company is seen as insecure and has a lower s/p and the div is the reward to the investor for the additional risk of holding the share

OR it could mean a company has a strong cash flow and low CAPEX

Question 15

What Div yield would you expect for a High PE company?

Answer 15

LOW

Question 16

Dividend Cover ratio?

Answer 16

Div Cover = EPS / Div/share

Question 17

what is Div cover useful for?

Answer 17

useful guide for directors as to what profits are being paid to shareholders

Question 18

what does div cover show?

Answer 18

Indicates the stability and growth of dividends

Question 19

Interpretation of div cover =

Answer 19

less than 1 = suggest uncovered dividend
high div cover = company is retaining most o fits earnings probs with the intention of reinvesting for future growth - common for high growth companies

Question 20

What is an uncovered div?

Answer 20

company is using retained earnings to pay dividend - could be cause for investor concern

Question 21

What is P/E ratio?

Answer 21

PE = Price of share / EPS

Question 22

What does PE ratio show

Answer 22

Valuation of shares

Question 23

Interpretation of PE

Answer 23

High PE = investors willing to pay premium for high earnings growth or share is over prices (tech companies can have PE of 20)

Low PE = shares are relatively cheap compared to the average for sector or very low PE could mean a security in distress

Question 24

Shortcomings of PE (x2)

Answer 24

1) If a company doesn’t have earnings or has negative earnings then PE is useless
2) Hard to compare - e.g if one company is growth and the other pays a high div