While reviewing the financial statements of an entity, an investor should know how to interpret the investor ratios. Investor ratios can be used to decide the health of a company. Investor ratios can mean the difference between investing in a good or a bad organisation. When a company makes profits, directors have two choices with regards to these profits: either pay out dividends or reinvest profits. Some investors are looking for a good yield while other investors are looking for growth. They are willing to sacrifice short-term returns, instead they want the share price to go up in order to make a return. Below are some of the investors ratio that you would need to know about:
Earnings per share
Also referred to as EPS, is profit after tax minus preference dividends divided by the weighted average (WA) number of ordinary shares. This ratio represents the amount of profit that in theory could be paid out to shareholders. The questions to ask here are:
• is earnings per share (EPS) of the company under consideration is consistent? or
• is it growing or reducing?
Earnings per share are easy to understand and figures are readily available but research has shown a poor correlation between earnings per share growth and shareholder value. Accounting treatments can also distort results.
Dividend per share
Generally known as DPS, divided per share is annual dividends divided by the weighted average number of ordinary shares. Annual dividends include total dividends paid out by an organisation in 1 year including interim dividends but does not include special dividends.
Dividend per share is used by those investors, who are assessing different entities to invest in and who prefer organisations who pay out dividends. One important point to consider here is that dividend per share ratio may not reflect a complete picture and position. Some organisations may retain their profits for future investments, instead of paying out dividends to current shareholders. This way, they can enhance the value of their shares and overall value of the company.
Dividend yield is dividend per share divided by current share price. This ratio represents the percentage return an investor is making in relation to the organisation’s current share price. Investors who are looking for good yields or returns on their investment will be interested in dividend yield. Dividend yield is good for investors to use as a comparison against other investment opportunities.
Dividend cover is profit after tax less preference dividends divided by dividends paid. Dividend cover is a measure of an organisation’s ability to pay dividends. It shows how many times over the profits of an organization could have been used to pay dividends. For example, if an organisation’s dividend cover is 2, this means that the organization’s profit was twice the amount of dividends paid out to shareholders. Generally, an organisation’s aim is to sustain a dividend cover of 2 in order to avail adequate financing through retained earnings, while at the same time providing a reasonable return for its shareholders.
There are many accounting firms in Singapore, who can provide services for the interpretation of financial statements for potential investors. So, if you are confused about anything or need further guidance, we suggest you to contact these professional firms.