Measures of Return on Investment and Risk Flashcards
What does dividend yield measure?
equity shareholder’s annual cash return on
investment
If the dividend yield of Sainsburys is 1.56%, what does that mean?
Sainsbury’s shareholders receive 1.56% dividend for every
£1 invested (at current share price levels)
What does the dividend yield tell us?
how much of the investment does the company return in cash
High dividend yield means…
a higher portion of profits back to investors
through dividends.
What does the dividend cover show us?
Shows number of times dividend is ‘covered’ by current profits
What does the dividend cover indicate?
how likely it is that company will be able to
maintain dividends if profits fall; Measure of risk
If Sainsburys dividend cover is 2.08, what does this mean?
Sainsburys current profits are over two times its current dividend.
What does earnings per share (EPS) measure?
profitability, ability to pay dividends
What does the profit in EPS represent??
profit available for distribution to equity shareholders
If Sainsburys EPS is 5.8 pence/share, what does this mean?
Sainsbury generated profits of 5.8 pence per share.
Basic vs Diluted EPS
-Basic EPS: takes account of all equity shares in issue
- Diluted EPS: takes account of shares that may result if there
are financial instruments which might be converted into shares
in the future because this conversion would ‘dilute’ the EPS
What does return on equity indicate?
performance – how well managers
use funds invested by shareholders
How do you know when ROE is good?
ROE should exceed cost of equity capital for the firm to be regarded as a success.
What do you need to remove to calculate ROE from the perspective of
parent shareholder?
Minority interest
What is a minority interest?
company ownership aside from the parent
If Sainsburys ROE is 1.77%, what does this mean?
Sainsbury has generated a return of 1.77% on equity invested by controlling shareholders
What does the price earnings ratio measure?
Compares amount invested in one share with earnings per share
What does the price-earnings ratio represent?
the number of years of current earnings that investors are prepared to buy
What is a common range for (P/E)?
10-25
P/E is a reflection of what two main things?
Risk: low PE ratio more risk
Expected earnings growth potential: high PE, firm expected to grow
What causes variations in PE?
- Overall level of stock market
- Industry
If Sainsburys PE is 36.1, what does this mean?
Sainsbury’s investors need 36 years to recoup their investment at current earnings levels
What is the market to book ratio?
Relationship between stock market value of shareholder equity and accounting value of shareholder equity.
What does the market to book ratio indicate?
whether a company is under- or overvalued… or whether market expectations of the company are high or
low.
If Sainsburys has a market to book ratio of 0.64, what does this mean?
Sainsbury investors are paying £0.64 for every £1 of net assets (book equity value)
What is interest cover?
Finance cost net of finance income; how many times does the profit for the period ‘cover’ the interest that has to paid;
What does interest cover indicate?
how much of a cushion is there once the
interest is paid
If Sainsburys has an interest cover of 1.78, what does this mean?
Sainsbury’s current operating profit can cover current interest expense 1.78 times.
What is gearing/leverage?
the relationship between fixed
interest capital (e.g. loans, debentures, preference shares) and
the amount of equity capital (i.e. shares).
Highly geared/leveraged firm =
a firm with a lot of debt
How is equity calculated?
Equity = share capital + share premium account + reserves + retained profits
How is debt calculated?
Debt = preference shares + loans + bonds + other non-current borrowings
Where is the debt-equity ratio used most?
Financial press
If Sainsburys has a debt equity ratio of 111%, what does this mean?
Sainsbury debt is 111% of its equity.
What does debt-equity ratio tell us?
the proportion of corporate debt to equity.
Typically, higher proportions of debt make the company more risky
Where is the gearing ratio used most?
Accounting
How is debt expressed in a gearing ratio?
As a fraction of the total capital
If Sainsburys has a gearing ratio of 53%, what does this mean?
Sainsbury debt makes up 53% of total capital.
What does a higher gearing ratio tell us?
Gearing ratio tells us the relative proportion of corporate debt to equity. Typically, higher proportions of debt make the company more risky
Is high gearing a good thing?
Though it increases profit available for
distribution as dividends and it is deductible for tax purposes, if there is MORE debt there is MORE financial risk and MORE volatility so not good
What are the implications of gearing?
High risk high reward.
Increase in profit (before charging interest) in high geared company will result in a proportionately greater increase in
the profit compared with the low geared company- but the REVERSE occurs BAD times.
What are indicators of good investments (better future expectations)?
-High P/E
-High MTB
What are indicators of low risk?
-High P/E
-High interest cover
-Low gearing ratios
