Definition and Purpose of Shareholder Ratios

Definition of Shareholder Ratios

Shareholder ratios, or investment ratios, are financial indicators used to measure the return on investment (ROI) for shareholders. They provide insights into the financial stability, profitability, and overall investment worthiness of a public limited company.

Classification of Shareholder Ratios

Earnings per share (EPS): This ratio is calculated by dividing the net income of the company after tax (minus any dividends on preference shares) by the number of outstanding ordinary shares. A higher EPS encompasses a more attractive investment opportunity.

Price to earnings ratio (P/E): This is calculated by dividing the market price of one share by the earnings per share. The P/E ratio reflects investors’ expectations of a company’s future growth.

Dividend yield: This ratio reflects the return that a shareholder receives in the form of dividends. It is calculated by dividing the annual dividend payment by the market price per share.

Dividend cover: This ratio shows the number of times a company can afford to pay dividends out of its profits. A higher ratio is generally encouraging as it suggests the dividend is well covered by profits.

Purpose of Shareholder Ratios

Evaluate Profitability: Shareholder ratios allow investors to assess the profitability of a company, helping them to decide whether or not to invest.
Risk Assessment: These ratios provide the potential risk associated with investing in a particular company. A lower ratio may indicate higher risk.
Performance Comparison: Shareholder ratios offer a standardised comparison between different public limited companies or different sectors in the market.
Income vs Growth: These ratios help distinguish income-generating companies from those primed for growth. A company with a high dividend yield may be a good choice for income-focused investors, while a high P/E ratio might indicate a growth company.
Management Efficiency: The efficiency of a company’s management in using the investor’s money to generate returns can be evaluated using shareholder ratios.
Trend Analysis: By tracking these ratios over time, investors can identify trends, assess the company’s financial health and make informed investment decisions.