Chapter 3 - Ratios Etc Flashcards
Earnings Per Share
- What is it
- Drawbacks
- Net income (payable to ordinary shareholders) LESS PREFERENCE SHARES Div
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Ordinary Shares issued - Absolute number
- Profit that could be paid as ordinary dividend, calculated after all expenses
- Most useful for comparisons in same business
- Paid after corporation tax, interest and preference dividends
- Looking for trends*
Drawbacks:
- Accounting - Depreciation, amortisation
- Share buy back (would reduce number of shares which would increase EPS
PE Ratio
What is it
Formula
Drawback
Forward v’s trailing price earnings price ratio?
PE Ratio:
Share Price
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Earnings per share
You’ll just get a number
- Is share cheap or expensive
- provides market expectation of company earnings GROWTH POTENTIAL
- Time in years it would take current EPS to repay share price (if earnings remain same and paid out what it could in dividends)
- High PE = Greater -received ability to grow EPS/ Higher quality
Drawback:
- Doesnt take into account risk
- Size of company eg could be tiny company
- Doesnt take into account EGR
- Hard to compare firms in different sectors
GH: Market view of earnings growth potential of company. Should be used to compare companies in same sector. PE ration higher than average for sector suggests high demand for those shares. SHares relatively expensive but investors expect to be compensated by higher than average earnings in future.
A lower ratio than average suggests that a company is not greatly favoured by investors/has poor growth prospects
Forward P/E :uses future earnings/profit guidance .
- Estimate/subjective
Trailing- Uses last 12 months profit
- PAst performance not necessarily guide to future
PEG ratio
What is it
- PEG ratio
P/E ratio
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Expected growth rate EGR
- looks at future earnings growth so More accurate
PEG < 1 = buy
PEG. 1 = Fair
PEG> 1. = Sell
GH: Helps determine stock value whilst taking the company’s earnings growth into account. It provides a more complete picture than PE ratio on its own.
Lower the PEG ratio, the more the stock may be undervalued, given its earnings performance . Under 1 means shares may be undervalued, over 1 = overvalued
Price to Book Value Ratio
When used
Price to Book Value Ratio:
Is share cheap?
Share Price
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Book value per share. (BV/no.ordinary shares)
- could for asset intensive companies
- no good for dividends
Less than 1 could be good
More than 2 paying too much
Dividend Yield
What is it
DIVIDEND YIELD:
- Dividend per share
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Share price - Think property rental - Yield would be rental /house value. What’s income compared to share price?
Measures annual return on ordinary shareholders investment. May be compared with what can be obtained with some other company - Indication of dividend return on a share
- method to compare dividend with other investments (EG property rental)
- Low yield indicates ability for high growth vice versa
Dividend Cover
- Net Profit
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Dividend
OR
EPS
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DPS
measure of the strength of a dividend payment relative to earnings
How many times can dividend be paid out of earnings? Higher the better
Less than 1 isn’t good as paying away more dividend than earnings (raid reserves)
Profit after tax and preference dividends used in calculation to represent profit available for distribution as dividends to ordinary shareholders.
Represents the number of times a dividend is covered by earnings and shows how likely it is that the company will be able to maintain future dividends on ordinary shares at current level if profits were to fall in future years
NAV per Share
- NAV =. Total assets attributable to ordinary shareholders
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No. Of shares in issue
Net assets = Total assets - total liabilities - value of preference shares
A share would normally be expected to sell at a premium to its net asset value , as investors would be willing to pay something for goodwill ie the company’s management , expertise and reputation
Gordons Growth model
- GGM
Potential shortfalls with ratios (4)
- Historic data -no guide to future
- Accounting - policies
- Financial statement contains subjective elements
- Only as good as source material
- Shouldn’t be considered in isolation - need to compare to sector/peers/trends
Pay out ratio
What is it
Dividend per share
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Earnings per share
(Flip side of Dividend cover)
Represents the % profit that has actually been distributed as a dividend to ordinary shareholders
- High ratio may not be sustainable if profits decrease. Low ratio indicates company is focused on retaining its earnings rather than pay dividends
- Low ratio indicates growth companies
Book Value per share
Ratio
- Used to evaluate a stock price. Is it undervalued?
If BVPS higher than share price = undervalued - value of equity share (NAV = Total assets- Total liabilities )
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Number of outstanding shares
Measures a firm’s book value (NAV)of a firm on a per share basis
Book value reflects total value of assets that could be paid out if company were to be liquidated (AKA equity balance)
- When a stock is undervalued. It will have a higher BVS on relation to it’s current share price
- Outstanding stock shown as Capital Stock
Drawbacks:
- Book value may differ from market value
- current valuation may not factor in future earnings
- not suitable for companies with lots of intangible assets
- distorted by big share movement
- not suitable for companies in different sectors
- output not robust
. Low ration doesn’t necessarily mean undervalued
-low PB may be function of terminally falling share price
