Ratios - what they mean Flashcards
What is EPS and what does it mean?
Earnings (net profits) attributed to ordinary shareholders
÷
No. of ordinary shares in issue
Shows what each share is actually earning
Enables investors to see what trends there are i.e. is it an improving picture or not?
Generally speaking, the higher the ratio, the better
What is dividend cover and what does it mean?
EPS
÷
DPS
It indicates how sustainable dividends are by showing how many times dividends could be paid by the company when paid out of the current earnings.
Dividend cover of 2 or more is seen as healthy; less than 1.5 indicates the potential growth prospects for the business / ability of the business to re-invest.
Generally, the higher the ratio, the more attractive the share.
Higher dividend cover = retaining greater proportion of earnings = more sustainable = may be distorted by other factors
What is the payout ratio and what does it mean?
DPS
÷
EPS
It indicates how much of a company’s profits has been distributed when compared with earnings generated
A payout ratio of 0.5 or less is seen as healthy i.e. Only 50% of the profit available was distributed
Generally, the lower the ratio, the more attractive the share.
What is dividend yield and what does it mean?
Dividend per share
÷
Current share price
(x100)
It shows how much ‘income’ the share will produce as a %. Obviously, this ignores any capital growth.
The general rule is the higher the ratio, the more attractive the share.
What is the price earnings to growth ratio (known as the PEG ratio) and what does it tell us about a company?
Current share price / EPS
÷
Expected Earnings per share growth
It is a more realistic measure of the P/E ratio as it considers the expected growth of the company’s earnings.
Less than one indicates that the shares are potentially attractive.
This measure can also been misleading as the Expected Growth Earnings figure is given by the company.
What is the liquidity ratio and what does it mean?
Current assets - stock
÷
Current liabilities
This shows how easily a company can meet a sudden cash call. In other words, how well will it stand up if there is a crisis or emergency.
In this case, the higher the ratio, the more able it is to repay its short term debts.
What is return on equity (ROE) and what does this tell us about a business?
Net profit (after tax and preference dividends have been paid)
÷
Capital and reserves (shareholder equity) - long term borrowing
It shows the percentage return the company is achieving on the amount of funds provided by shareholders.
Shows ability to generate profit and how efficiently it uses shareholder capital.
Generally, the higher the ratio the better.
Key aspects of a preference share
They pay a non guaranteed, fixed dividend
They are ranked ahead of ordinary shareholders for both income and return of capital
They only offer voting rights if the preference share is ‘cumulative’ and is in arrears
What is the price earnings ratio (known as the P/E ratio) and what does it tell us about a company?
Current share price
÷
Earnings per share
It shows how profitable a share is, i.e. how much it pays out as a % of the current price and how well it can continue to generate earnings.
A high P/E ratio indicates shares are in demand.
Only use P/E ratio for companies in same sector.
What is interest cover and why should I be interested?
Profit before interest and tax
÷
Gross interest payable
It shows how well a company can repay debt. It shows how many times interest payments are covered by gross profits.
Note: this does not apply to an ordinary share. It applies to preference shares which pay interest instead of dividends.
Gernerally speaking, the higher the ratio, the better.
What is the quick ratio and what does it tell us?
Current assets / current liabilities
Higher number means company is in strong position
Can easily repay short term debt from cash without use of other assets
What is net asset value (NAV) and what does it mean?
Net assets attributable to ordinary shareholders / number of ordinary shares in issue
Measures amount available to shareholders if company were to sell all assets, pay all liabilities and distribute balance to shareholders
Value is for accounting purposes
Limitations of investment ratios
Different accounting policies between companies makes comparisons difficult
Change of accounting policy over time makes ratios misleading
Ratios are based on historic data
