Treasury Practice

Investor Ratios

Published: Sep 2004

Sometimes it is important for the treasurer to understand what investors are looking at when considering a company as a potential investment. Unless a rights issue is planned, the share price alone should have no impact on the company’s day-to-day financial position. This is because a change in the share price will have no immediate impact on the company’s liquidity.

In practice, shareholders, through the board, influence the day-to-day operation of the business. Each shareholder, especially the institutions, will have target returns from their share, and other, investments in the company. These institutions will expect certain results from some or all of the following ratios. If these are not met, institutions may either require a change in operational direction or sell their shareholdings. Either decision may have a serious impact on the treasurer’s ability to perform his or her job.

The key ratios which investors use are:

  • Earnings per share (eps) = \(
    \frac{Shareholders’ \: profitannual\: profit \: available\: for \:distribution\: to \:shareholders}
    {Average\: number\: of\: equity \:shares \:during\: the\: year}\)
  • Price/earnings (P/e) ratio = \(\frac{Current\: market \:share\: price}
    {Earnings\: per \:share}\)
  • Dividends per share = \(\frac{ Dividends\: paid\: to\: shareholders }
    { Average \:number\: of\: equity\: shares}\)
  • Dividend yield   = \(\frac{Last\: annual \: dividend \:payments }
    { Current\: market\: share \:price }\)
  • Dividend cover  = \(\frac{Net\: shareholders’\: profit}
    {Dividends\: paid \:to \:shareholders }\)

There is much debate over what constitutes the most accurate measurement of a company’s profitability. To some extent, this debate is irrelevant. Investors will have their own views on whether a company constitutes a ‘good investment’. These views will vary, but are typically based on a combination of the ratios stated above and a view of the future.

It is important that companies maintain a good relationship with their institutional investors in particular, so that they can understand what the shareholders want. Irrespective of the narrative in financial reports, much emphasis is placed on the simple numbers, within both the existing shareholders’ base and the wider marketplace. Underperformance can affect existing shareholder relationships as well as the future ability to raise funds both through share issuance and otherwise.

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