EPS – Earnings Per Share

The EPS formula does not include preferred dividends for categories outside of continued operations and net income. Earning per share for continuing operations and net income are more complicated in that any preferred dividends are removed from net income before calculating EPS.

The portion of a company’s profit allocated to each outstanding share of common stock earning per share serves as an indicator of a company’s profitability. 

EPS     =          Earnings (Profit)

Weighted number of equity shares in issue

When calculating, it is more accurate to use a weighted average number of shares outstanding over the reporting term, because the number of shares outstanding can change over time.  However, data sources sometimes  simplify the calculation by using the number of shares outstanding at the end of the period.

Diluted EPS expands on basic EPS by including the shares of convertibles or warrants outstanding in the outstanding shares number.

Price Earning Ratio – P/E

The P/E ratio (price-to-earnings ratio) of a stock (also called its "P/E", "PER", "earnings multiple", or simply "multiple") is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation, a higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower P/E ratio. The P/E ratio has units of years, which can be interpreted as "number of years of earnings to pay back purchase price", ignoring the time value of money. In other words, P/E ratio shows current investor demand for a company share. The reciprocal of the PE ratio is known as the earnings yield. The earnings yield is an estimate of expected return to be earned from holding the stock if we accept certain restrictive assumptions (a discussion of these assumptions can be found here).

P/E Ratio            =         Market price per share

                                               EPS

Dividend Yield

A financial ratio that shows how much a company pays out in dividends each year relative to its share price.  In the absence of any capital gains, the dividend yield is the return on investment for a stock. Dividend yield is calculated as follows:

Quantifies the relationship between DPS (dividend per share) and market price per share.

Dividend Yield                =       DPS (Dividend Per Share)

                                                         Market Price Per Share

Dividend yield is a way to measure how much cash flow you are getting for each rupee invested in an equity position - in other words, how much "bang for your buck" you are getting from dividends. Investors who require a minimum stream of cash flow from their investment portfolio can secure this cash flow by investing in stocks paying relatively high, stable dividend yields.

Note that dividend yield changes because of two things. First, the stock price goes up (yield drops) or down (yield increases). Second, the company increases the dividend (yield increases) or cuts the dividend (yield drops). However, note that the yield being paid at the time we purchase the stock is what we investment will earn from dividends as long as you hold the stock, regardless of what the share price does. Dividend yield is an important part of your rate of return on an investment. If we purchase a stock that goes up by 8% in a year while paying a 3% dividend, then we've earned 11% on your money.

Dividend Cover

This show how many times over the profits could have paid the dividend. For example, if the dividend cover is 3, this means that the firm's profit attributable to shareholders was three times the amount of dividend paid out.

Dividend Cover   =             Pat  - Prefereance Dividend   

                                                 Ordinary Dividend 

Dividend cover is a measure of the ability of a company to maintain the level of dividend paid out. The higher the cover, the better the ability to maintain dividends if profits drop. These needs to be looked at in the context of how stable a company's earnings are: a low level of dividend cover might be acceptable in a company with very stable profits, but the same level of cover at company with volatile profits would indicate that dividends are at risk. 

Because buyers of high yield shares tend to want a stable income, dividend cover is an important number for income investors. 

 

The inverse of this ratio is the proportion of earnings that belong to ordinary shareholders which are distributed to them. This is known as the dividend payout ratio.

A company who has a dividend cover ratio of 1.0 pays out all earnings in dividends. This means that should earnings fall, the company might be forced to cut annual dividend payments. If the company has financial reserves, it may be able to make the annual payment from these cash reserves in the short term.

Many firms use annual dividend payments as a signal to shareholders and the market of confidence, so in the short term, directors will be reluctant to reduce payments, unless the firm is in trouble.

Dividend Payout

The dividend payout ratio measures the percentage of a company's net income that is returned to shareholders in the form of dividends. 

          Dividend Payout =                       Ordinary Dividend       

                                                        Pat - Prefereance Dividend

The Dividend Payout Ratio is a model for Cash Flow Measurement used by investors to determine if a company is generating a sufficient level of cash flow to assure a continued stream of dividends to them. It is also a measurement of the amount of current net income paid out in dividends rather than retained by the business.

The Dividend Payout Ratio Formula (Cash Flow Measurement Formula) is relatively straightforward: Divide total annual dividend payments by annual Net Income plus Non-cash Expenses minus Non-cash Sales.

Calculating the Dividend Payout Ratio for one year provides a very unreliable indication only. A better approach is to run a trend line on the ratio for several years to see if a general pattern of decline or increase emerges.

This ratio is useful in projecting the growth of company as well. Its inverse, the Retention Ratio (the amount not paid out to shareholders in the form of dividends), can help project a company’s growth.

Measuring Liquidity

Current Ratio

Current Ratio      =                                Current Assets        X 100

                                                             Current Liabilities           

The ratio is mainly used to give an idea of the company's ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health, it does not necessarily mean that it will go bankrupt - as there are many ways to access financing - but it is definitely not a good sign.

The current ratio can give a sense of the efficiency of a company's operating cycle or its ability to turn its product into cash. Companies that have trouble getting paid on their receivables or have long inventory turnover can run into liquidity problems because they are unable to alleviate their obligations. Because business operations differ in each industry, it is always more useful to compare companies  within the same industry.

This ratio is similar to the acid-test ratio except that the acid-test ratio does not include inventory and prepaid as assets that can be liquidated. The components of current ratio (current assets and current liabilities) can be used to derive working capital (difference between current assets and current liabilities). Working capital is frequently used to derive the working capital ratio, which is working capital as a ratio of sales.

Quick Ratio

An indicator of a company's short-term liquidity. The quick ratio measures a company's ability to meet its short-term obligations with its most liquid assets. The higher the quick ratio, the better the position of the company.

The quick ratio is calculated as:

  Quick Ratio       =         Current Assets   - Inventory     X 100

                                                         Current Liabilities              


The quick ratio is more conservative than the current ratio, a more well-known liquidity measure, because it excludes inventory from current assets. Inventory is excluded because some companies have difficulty turning their inventory into cash. In the event that short-term obligations need to be paid off immediately, there are situations in which the current ratio would overestimate a company's short-term financial strength.