4 Investment Ratio Calculations You Need to Master
Regular queries we get surround the calculation of investment ratios – these are usually tested in R02 and often come up in AF4 as well so we thought a working example of how to work some of them out might help. Those studying for their CII R02, J10, AF4 or AF5 exams will find this useful in their revision.
Our example concerns a PLC called Bright-eyed Training; they have profits (available for ordinary shareholders) of £100,000. They have issued 150,000 ordinary shares. Their current share price is 490p and the recent dividend paid was 12p.
We are going to work out earnings per share, dividend yield, dividend cover and the price earnings ratio.
Calculating Earnings Per Share
Firstly EPS (earnings per share), this figure is important and must be published in a company’s account enabling an investor to see the trend in the company’s profitability.
The EPS for Bright-eyed Training is worked out as: Profit attributable to ordinary shareholders divided by the number of ordinary shares in issue – so £100,000/150,000 = 66p.
Calculating the Dividend Yield
Next is the dividend yield which measures the dividend as a percentage return on the current share price.
Dividend yield for Bright-eyed Training is worked out as the dividend per share divided by the current share price multiplied by 100 to get a percentage. This is 12p/490p = 2.45%. An investor can now use this information to compare this return with the returns that could be achieved on other investments.This is useful for brushing up on your investment ratio calculations for your #CII exam. Click To Tweet
Calculating Dividend Cover
Next, dividend cover which measures how many times the dividend could be paid out of the available current earnings. This can give an investor an indication as to the margin of safety the company has in paying the dividend.
On an individual share basis, the dividend cover for Bright-eyed Training is the EPS divided by the dividend per share which is 66p/12p = 5.5.
Calculating Price Earnings Ratio
Finally, PE ratio; this can be seen as how the market views the potential for future growth in earnings.
The P/E ratio for Bright-eyed Training is worked out as the share price divided by the EPS figure which is 490/66p = 7.42. A simple way of looking at this figure is that it gives the number of years the company would need to generate enough value to cover the cost of the share at the current market price.
These ratios can be useful in helping someone decide whether to invest in a particular company but they do need to be used with caution as often the information being used is historical so can’t necessarily be the most accurate guide for future performance.
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