There are five main ratios that can be used by shareholders in order to assess the worth of a particular company and their shares:
- Earnings per share (E.P.S).
- Price/ Earnings (P/E) ratio.
- Dividend per share.
- Dividend yield.
- Dividend cover.
This measures the company's potential dividends that it could pay to shareholders. It is calculated using the following formula:
For example, if a company has profit after tax of £12m and it has issued 40 million ordinary shares, then its E.P.S. would be:
This means that every ordinary share could pay a dividend of 30 pence IF all the profit after tax is distributed as dividends. However, it is most likely that some of the profit after tax will be kept in the company for re-investment (this is called retained profit).
Clearly the shareholders would want as much of the profit after tax as possible to be payable to themselves.
This measures the market price of the share as a proportion of the earnings per share calculated above. It is calculated using the following formula:
For example, if the current market price for a company's share is £1.50, and the earnings per share is 30 pence, then the P/E ratio would be:
This answer indicates that it would take an investor 5 years to recover the cost of the share. This figure would need to be compared to other companies' P/E ratios before a judgement could be made.
In general, the higher the P/E ratio, then the better the expectations of the company's future profitability. However, the share price of the company is likely to fluctuate frequently, and therefore the P/E ratio of the share will not be the same for very long - this can make it difficult to compare the P/E ratio with other companies.
This measures the size of the dividends that the company actually pays to its shareholders. It is calculated using the following formula:
For example, if a company has profit after tax of £12m (and issues 25% of this as dividends) and it has issued 40 million ordinary shares, then its dividend per share would be:
This means that every ordinary share would pay a dividend of 7.5 pence. The remaining £9m of profit after tax would be retained for future investment. Clearly, the shareholders would want the dividend per share to be as high as possible, in order to maximise their return on their investment.
This shows the dividend per share expressed as a percentage of the market price of the share. It is calculated using the following formula:
For example, if a company had a dividend per share of 7.5 pence, and a market price of £1.50, then the dividend yield would be:
This is not a very high return for the risk involved in investing money in shares. This figure would need to be compared to other investments (e.g. other companies, banks, etc) to see if it is providing a competitive return.
This measures how many more times the dividends could have been paid out of the profit after tax. It is calculated using the following formula:
For example, if a business had profit after tax of £12m and it paid total dividends of £3m, then the dividend cover would be:
This means that the company did not pay the shareholders a significant proportion of the profit after tax in the form of dividends - the company has actually only paid a quarter of their profit after tax as dividends.
This means that the company kept much of the profit after tax as retained profit for re-investment.