The first measure of a share's value to you is what return you can expect in the way of annual dividends. Suppose you want to buy a share which you intend to sell in 3 years time. Then the share is worth the sum of the 3 year's dividends plus the value you can sell the share for at that time which you hope to be higher than the price at which you bought. This, people believe, is the capital growth.
Consider the position of the person buying the share from you. They intend to keep the share for, say, 10 years. If he calculates the value of the share in the same way that you did, then his starting point is the next 10 years' dividends. The capital growth that you got from him was actually his estimate of the dividend stream.
Henceforth, a share is worth the sum of future dividends over the long term not just the period that the person intends to hold the shares. If you think only in terms of the capital growth of shares it will surely catch you out.
Key ratios
- Yield
- Price Earnings
- Capital Gearing
- Income Gearing
- Return on Capital Employed (RoCE)
- Pre-tax Profit Margin
Percentage of dividend over price.
Take note if a company has the profits and cash to maintain or increase the dividend.
When a yield suddenly goes very high, it may means that the share price has dropped significantly. That often means the market or investors are unsure whether the dividend will be maintained either now or in the future.
Share price divide by Earnings per share.
Percentage of long term debts over shareholders funds plus long term debts.
Low gearing is less than 10%.
Medium gearing is about 33%.
High gearing is about 66%.
Ratio as interest payable divided by earnings before interest and tax.
Indicates the company's ability to service its debt.
Low gearing is less than 25%.
Medium gearing is between 26% and 75%.
High gearing is above 75%.
Calculated as net profit before tax divided by long term capital.
Indicator of managerial performance.
Whether to invest in preference to earning interest in a safer saving scheme.
Low profitability 0 to 10%.
Medium profitability is between 10% and 20%.
High profitability is above 20%.
Net profit before tax as a percentage of sales revenues.
Low margin is below 2%.
Medium margin is between 4% and 8%.
High margin is above 8%.
Highly dependent on the industry you are looking at. For example, what is a poor margin for technology companies could be a very good one for a bookshop.
Note: Extracted from book "Smart Finance" by Langdon, Ken and Bonham, Alan.
