Investment Ratios Flashcards
What is the Liquidity ratio formula and what does it measure?
This is a very simple ratio used to measure a business’s ability to be able to meet their debts:
Current assets – stock / current liabilities
What is the gearing ratio formula and what does it measure?
This is simply the measure of borrowing is a business:
Long term debt / shareholder funds
Of course, all ratios have limited value. Different factors need to be taken into consideration, but they are a useful
tool to be used alongside each other and other forms of analysis.
In the main, these ratios look at historic data which although exact will be, by definition, out of date.
What is the dividend yield formula and what does it measure?
This is essentially the return on a share and measures the dividend as a percentage return on the current share
price. Good for comparing the return from the share with the those of other shares, bonds or cash deposits. The higher the better
DPS/ Share price
Shows the return that investors
are receiving from the shares in
the way of annual income.
A high Dividend Yield would
demonstrate that the investor is
receiving a good return from the
shares, but does not necessarily
mean that the level of profit
distribution is sustainable.
What is the dividend cover formula and what does it measure?
Measures how many times the dividend could be paid out of the current earnings. It provides an indication of the safety margin that the company can still pay its dividend
and hence the riskiness of an investment. Can be important to investors who rely on the income. It can be calculated in one of two ways:
EPS/DPS
Profit to O/S / Dividend paid
Shows how many times the
dividend could have been paid
from the period’s profits.
A dividend cover of less than 1
would suggest that the company
has to utilise reserves.
What is the price earnings ratio formula and what does it measure?
Measures the relationship between share price and earnings per share. Essentially it states how highly investors value the earnings of the company and outlook on potential for future growth of earnings. The higher the PE the greater the expectation for future growth! You need to work out EPS first.
share price / EPS
Where the ratio is lower than the average for firms in its sector, this would suggest that the market holds the firm in a negative
light and is not positive about the future of the company. The reverse is also true – the market is prepared to pay a premium for
the stock in the expectation that it will increase in value in the future.
Shows how highly the investors value the earnings of the company.
A high P/E ratio typically demonstrates that
The investors are willing to pay more for shares and that demand is high, or The share price may be overvalued based upon the profits generated
What is the net asset value formula and what does it measure?
This shows the share of the assets of the company attributable to each share
net assets to O/S / no of O/S in issue
Remember that net assets attributable to ordinary shareholders is calculated as the total capital minus secured and
unsecured loans and preference shares.
The NAV is very useful for takeovers in particular where it is possible for the company taking over another to see whether the share price represents a fair value for the assets they will acquire and how much they will be paying as a premium for goodwill.
The value of the company for
accounting purposes.
Reflects the true value of the
company, based on the balance
sheet (assets less liabilities) as
oppose to market sentiment.
