Investment Ratios
Investment ratios are of benefit to investors comparing stocks as they provide ways of comparing different share prices. While there is a large amount of financial numbers and statistics available, there are five main ratios which most investors study before making investment decisions.
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Earnings per share, or EPS, is one of the most widely followed ratios and is published in the company’s accounts. EPS is calculated by taking the total profit which would be attributable to ordinary shareholders and dividing this by the total number of ordinary shares in issue. The profit figure used is the profit after tax and any preference dividends have been satisfied. EPS gives investors a good indication of the overall profitability of the company because it is unlikely that all of the profits will be distributed as dividend in any year.
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If you divide the current share price by the EPS of the share you get the price to earnings ratio. Price to earnings is another widely followed ratio particularly when comparing the stocks of companies in the same sector. The ratio is seen as an indicator of how well valued the company is by investors with a higher ratio suggesting that investors are more optimistic about the company’s profitability in the future. Another way to think about price to earnings is as the number of years it will take the company to earn the same profit as the price of the shares.
Dividend yield is the ratio of the return on investment in the share. The yield is simply the dividend per share divided by the share price, expressed as a percentage. This can be used to compare the return on holding a stock to another share or type of investment. Dividend yield can be used to give an estimate of the return in future although there is no guarantee that dividends will continue to be paid at the same rate.
Dividing the EPS figure by the dividend will give the investor the dividend cover of the company. This is simply the number of years the company could pay the same rate of dividend for out of this year’s profit. A high number in this ratio suggests the company is holding a large amount of the profit back to reinvest in the business. This is not necessarily bad news for investors as this can generate growth in the company which will increase the share price.
The final ratio investors take into account is net asset value. This is the total of a company’s assets divided by the number of shares in issue and is the theoretical price shareholders would receive if the company stopped trading and all assets were sold. Again this is best used when comparing stocks in similar sectors as there can be significant differences between different businesses. Some companies will be valued at much more than their net asset value due to the additional value of goodwill and future orders.
Dividend yield is the ratio of the return on investment in the share. The yield is simply the dividend per share divided by the share price, expressed as a percentage. This can be used to compare the return on holding a stock to another share or type of investment. Dividend yield can be used to give an estimate of the return in future although there is no guarantee that dividends will continue to be paid at the same rate.
Dividing the EPS figure by the dividend will give the investor the dividend cover of the company. This is simply the number of years the company could pay the same rate of dividend for out of this year’s profit. A high number in this ratio suggests the company is holding a large amount of the profit back to reinvest in the business. This is not necessarily bad news for investors as this can generate growth in the company which will increase the share price.
The final ratio investors take into account is net asset value. This is the total of a company’s assets divided by the number of shares in issue and is the theoretical price shareholders would receive if the company stopped trading and all assets were sold. Again this is best used when comparing stocks in similar sectors as there can be significant differences between different businesses. Some companies will be valued at much more than their net asset value due to the additional value of goodwill and future orders.