What Is the Importance of Investor Ratios?

Ratio Description

Formula

Earnings Per Share EPS is calculated by dividing net after tax income of the company subject to deduction of dividend payable on preference shares (if any) by the weighted average number of shares during the year.

EPS is a very important investor ratio as it shows the company’s ability to generate and distributable profit for each share invested in the company. As a result, EPS is very dominant factor in determining a share’s market value.

EPS=

       Profit after Tax      /
Weighted Avg. no of shares

Price Earnings Ratio Price Earnings Ratio is calculated by dividing Market Value per share of a company by its Earnings per share.

The P/E ratio is used to gauge investor confidence in the company. It shows how much an investor is willing to pay for earning 1 Rupee.

P/E Ratio =

Market Value/
EPS

Dividend Payout Ratio Dividend Payout Ratio is calculated by dividing dividend per share by earnings per share.

It shows how much of the earned profit is being distributed to the shareholders and reflects the dividend retention policy of the company. If dividend payout is on the lower side it shows Company might be retaining funds for any strategic investment.

Dividend Payout Ratio =

Dividend Per share/
EPS

Example:

Based on the data above, solvency ratios would be as follows:

The company’s earnings per share (EPS) ratio is improving through the years due to an increase in profit after taxes.

The company share price didn’t increase much in the year 2014 as a result of which Price Earning Ratio (P/E) declined in the year 2014 as compared to 2013 despite an increase in EPS which shows that market didn’t fully recognize the improvement in company earnings potential. However, the same issue was corrected in the year 2015 where investors recognized company’s potential, and its market price rose significantly and as a result, the P/E ratio improved as well.

The dividend payout ratio shows the company’s profit retention policy. A company has many options to raise finance for its operations which include new equity, new long and short term loans, or profit retention. In our example above, this company is retaining a significant portion of its profit for the same purpose i.e. approx. 63% and 69% profit was retained in the year 2014 and 2015 respectively.

Working Capital Ratios

One thought on “What Is the Importance of Investor Ratios?”

  1. Nice article, i like it!

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