Stock Market Ratios

Stock Market Ratios are ratios which help equity shareholders and other investors to assess the value and quality of an investment in the ordinary shares of a company.


1. Dividend Yield = Dividend per Share / Market Price per Share


2. Interest Yield = Interest Payable / Market Value of Loan Stock


3. Earnings per Share = {Profit after tax, extraordinary items and preference dividends} / {Number of equity shares in issue and ranking for dividend}


4. Price/Earnings Ratio = Market Value per Share / Earning per Share


5. Dividend Cover = {Earnings available for distribution to ordinary shareholders} / {Actual dividend for ordinary shareholders}


Investors are interested in:

• The value (market price) of the securities that they hold
• The return that the security has obtained in the past
• Expected future returns
• Whether their investment is reasonably secure


(I) Dividend and Interest Yields

In practice, we usually find that dividend yield on shares is less than the interest yield on debentures and loan stock (and also less than the yield paid on gilt-edged securities)

The share price generally rises in most years, giving shareholder capital gain.

In the long run, shareholders will want the return on their shares, in terms of dividend received plus capital gains, to exceed the return that investors get from fixed interest securities.


(II) Earnings per Share (EPS)

EPS is widely used as a measure of a company’s performance and is of particular importance in comparing results over a period of several years.

A company must be able to sustain its earnings in order to pay dividends and re-invest in the business so as to achieve future growth.

Investors also look for growth in the EPS from one year to the next.

EPS must be seen in the context of several other matters:

(a) EPS is used for comparing the results of a company over time. Is its EPS growing? What is the rate of growth? Is the rate of growth increasing or decreasing?

(b) Is there likely to be a significant dilution of EPS in the future, perhaps due to the exercise of share options or warrants, or the conversion of convertible loan stock into equity?

(c) EPS should not be used blindly to compare the earnings of one company with another. When earnings are used to compare one company’s shares with another, this is done using the P/E ratio of perhaps the earning yield.

(d) If EPS is able to be a reliable basis for comparing results, it must be calculated consistently. The EPS of one company must be directly compared with the EPS of others, and the EPS of a company in one year must be directly comparable with its published EPS figures for previous years. Changes in the share capital of a company during the course of a year cause problems of comparability.

Note that EPS is a figure based on past data, and it is easily manipulated by changes in accounting policies and by mergers or acquisitions.



(III) Price/Earnings Ratio

P/E ratio is simply a measure of the relationship between the market value of a company’s shares and the earnings from those shares.

The value of the P/E ratio reflects the market’s appraisal of the shares’ future prospects. In other words, if one company has a higher P/E ratio than another, it is because investors either expect its earnings to increase faster than the other’s or consider that it is a less risky company or in a more secure industry.

(a) The relationship between the EPS and the share price is measured by the P/E ratio.

(b) There is no reason to suppose, in normal circumstances, that the P/E ratio will vary much over time.

(c) So if the EPS goes up or down, the share price should be expected to move up or down too, and the new share price will be the new EPS multiplied by the constant P/E ratio.


Changes in the P/E ratio of companies over time will depend on several factors:

(a) If interest rates go up, investors will be attracted away from shares and into debt capital. Share prices will fall, and so P/E ratio will fall.

(b) If prospects for company profits improve, share price will go up and P/E ratios will rise. Share prices depend on expectations of future earnings, not historical earnings, and so a change in prospects, perhaps caused by substantial rise in international trade, or an economic recession, will affect prices and P/E ratios.

(c) Investors’ confidence might be changed by a variety of circumstances, such as:

a. The prospect of a change in government
b. The prospect for greater exchange rates stability between currencies.



(IV) The Dividend Cover

The dividend cover is the number of times the actual dividend could be paid out of current profits and indicates:

(a) The proportion of distributable profits for the year that is being retained by the company

(b) The level of risk that the company will not be able to maintain the same dividend payments in future years, should earning fall.

A high dividend cover means that a high proportion of profits are being retained, which might indicate that the company is investing to achieve earnings growth in the future.


(source: BPP Learning Media)



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