Accounting (Year 12) - Ratios
Introduction to Market Ratios | Elucidate Video
Presented by: Christian Bien
What are Market Ratios?
Market ratios are used by investors to assess the market performance of a company listed on the share market.
They measure the performance (earnings per share), valuation (price to earnings ratio) and return (dividend yield).
Earnings Per Share
The Earnings Per Share ratio calculates the amount of profit after tax earned per ordinary share of the company. It used mainly to determine the likelihood of a higher dividend payout. It is calculated as the profit after income tax over the weighted average number of ordinary shares (see below for the calculation of the Weighted Average Number of Ordinary Shares).
High Number: Favourable, as the company is generated more profit per share, increasing the chance of a higher dividend payout.
Low Number: Unfavourable, as the company generates less profit per share, decreasing the chance of a higher dividend payout.
Weighted Average Number of Ordinary Shares
The weighted average number of ordinary shares refers to the average number of shares held by the company over the year. The 'weighted' part refers to the timing across the year. To calculate the weighted number of ordinary shares, identify the change amount of ordinary shares. For example, consider a Company with 10,000 shares. On the 100th day of the year, the company issued 5,000 additional shares, increasing the amount of ordinary shares from 10,000 to 15,000 shares.
To calculate the weighted number of ordinary shares, we calculate the sum of the proportion of the year that had 10,000 shares and the proportion of the year that had 15000 shares.
Between 0 - 100 days of the year, the Company held 10,000 shares.
Between 101 - 365 days of the year, the Company held 15,000 shares.
Hence, the weighted average is: = (100/365 * 10,000) + (265/365 * 15,000) = 2,740 + 10,890 = 13,630 shares
Price / Earnings Ratio
The price earnings ratio measures the value of the market price of a share to its earnings per share. The ratio measures how much an investor is willing to pay for a company's shares. For example, if a Company has a Price / Earnings Ratio of 5 times, it means that investors are willing to pay 5 times the value of its earnings.
In other words, a Company's earnings and share price is exactly the same, it will equal its share price in 5 years.
Higher Number: Investor are highly confident in the future prospects of a company. However, the flip side is that there is a greater chance of the company underperforming, increasing the risk associated with the investment and the chance it is overvalued.
Lower Number: Investors are not confident of the future prospects of a company. However, the flip side is that this presents a lower risk and the chance that the share is undervalued.
The dividend yield measures the amount of dividends paid relative to its market price. It measures the relative rate of return on investment in the shares of the company. For example, if the dividend yield of a company is 7%, you would receive a 7% return in the form of dividends if the dividend amount is consistent.
Higher Number: Favourable, as the company has historically paid out a high levels of dividends, increasing the chance of a higher rate of return on investment relative to its share price in the future.
Lower Number: Unfavourable, as the company has historically paid out a low dividend, increasing the chance of a lower rate of return on investment relative to its share price in the future.
Note: Capital Gains/Loss The dividend yield does not measure the capital gains or losses, that is the gains or losses due to fluctuating market share prices. These can exceed any gains made in the form of dividends.