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SHAREHOLDERS’ INVESTMENT RATIOS: GUIDE TO SHARE INVESTING

Updated on February 24, 2014

Stock investment allows third parties to obtain ownership of a company without necessarily having control and influence on the company’s management board. The management of the company furnishes the investors with financial information in the form of financial statements- hoping that the shareholders knows what to do with the information supplied to it.

The best that the shareholder can do with the financial information is to analyse the information provided to them in the light of facts in order to assess / ascertain the value and quality of an investment in the ordinary shares of a company.

The shareholders don’t just dabble into all manners of calculation. There are ratios that are of particular interest to the shareholders and are called shareholders’ investment ratios. Meaning, significance, and calculations of investment ratios will be discussed throughout the remaining part of this article.

INVESTMENT RATIOS

The ratios that every investor should look out for are:

  • Earnings per share (EPS)
  • Dividend per share (DPS)
  • Dividend cover (DC)
  • Price-Earnings ratio (P/E Ratio)
  • Dividend yield (DY)

NOTE:- the value of an investment in ordinary shares in a company listed on a stock exchange is its market value, and so investment ratio must have regards not only to information contained in the company’s published accounts, but also to the current price and the fourth and fifth ratios listed above involves using the share price.

EARNINGS PER SHARE (EPS)

EPS in common language is the amount of money that a unit of share is able to earn in a particular period. This tells us how a company is doing in relation to the number of shares it has. It is however worthy to note that there are other circumstances that affect the EPS (EPS dilution) figure like issue of new shares, rights issue, conversion of convertible loans, etc. These factors are taken care of by calculating different EPSs for a single period. IAS 33 produced by the IASB deals extensively on EPS.

EPS is calculated thus:

Net profit (loss) attributable to ordinary shareholders/ weighted average number of ordinary shares outstanding during the period. Note that the above formula is for the basic EPS. It demonstrates the earnings prowls of an entity.

DIVIDEND PER SHARE (DPS)

Dividend per share is the entitlement given to shareholders for investing in a company. it is usually in cent and therefore needs no further interpretation. But this should however be compared with what other company of similar size are paying.

DIVIDENDS COVER (DC)

This shows the proportion of a company’s profit that is retained for re-investment. If a company has a dividend cover of 2 for instance, it simply means that the company is paying out half of what it’s making to its shareholders.

Sharp movement in dividend cover calls for further investigation. A sharp fall in DC could mean that a company did not make good profit this year but, the management went ahead to pay the normal dividend, this shouldn’t be a cause of worry if there is prospect for growth in the company.

DC= EPS/ Dividend per share.

PRICE-EARNINGS RATIO (P/E RATIO)

This exhibits investors’ confidence on a particular share. A high P/E Ratio indicates a high level of confidence reposed on the stock in question by the investing public.

P/E ratio= current share price/ earnings per shares

DIVIDEND YIELD (DY)

DY simply means what you expect from your investment in the form of dividend. Investment yields is made up of DY plus capital appreciation

DY= current dividend/ current market value of the share (ex div) X 100%

A simple example I think will make you understand it more.

QUESTION

A company declares a dividend of 16 cents for the year ended July 31, its ex div share price is 315 cents, what is the dividend yield?

SOLUTION

16/315 X 100= 5.1%

You see, I told you it is dead simple. Just like this one, every other ratio is also simple.

By ex div, it means that share price have been adjusted for most recent dividend paid.

It should be understood that ratio analysis on its right has no value but, becomes meaningful when compared with some sort of yardstick like; information from other companies, past records, other industries, etc. Also, note that what we have done here is just an aspect of an overall investment analysis and should not be taken alone. It should be combined with other categories of ratios namely:

  • Profitability and return ratios
  • Long-term solvency and stability
  • Short-term solvency and liquidity
  • Efficiency (turnover ratios)

On a last note, let it sink into your head that ratio analyses are not definite- they are simply guide amongst other limitation of investment ratios analysis. These suggest why the title of this article reads; shareholders’ investment ratios: guide to share investing

Happy investing!

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    • profile image

      ruvarashe 

      6 years ago

      it was helpful and vital to a potential investor like me

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