Fundamental Analysis Tutorial – Introducing shares financial ratios

Analyst reports are put together by professionals that specialize in reading and interpreting the annual shares financial reports that we discussed in the previous lesson. When researching which shares to buy and sell you might want to make use of these analyst reports. They create these reports from the raw data in a company’s annual report to make forecasts and calculate financial ratios. These financial ratios are then used by analysts to compare the performance of a company to its previous financial ratios, and to industry averages.

There are of course, some limitations in the effectiveness of shares financial ratio analysis, you might get “analysis paralysis” by trying to absorb so much data, the data might be not be perfectly accurate, or probably the most likely of any of these limitations is that the data might have already been factored into a company’s share price which would obviously reduce its use as an effective timing signal. Limitations aside, reviewing the balance sheet and analyst reports will contribute to your building an objective case for your share investing decisions. Learning how to think objectively and be objective in all of your shares trading and investing decisions is one of the key strategies you will need to implement to become a successful investor. Objectivity essentially means removing the emotion from you decisions.

Dividend per share and dividend yield

The basic theme to successful share market investing is relating a company’s performance to the price of its shares. Through calculating the “per share” data we are able to compare earnings, debt and corporate health to a company’s share price. There are numerous ratios used by analysts to make valuations regarding a company’s shares. Let us now take a closer look at two of the more widely used of these ratios used by share market investors, dividend per share and dividend yield

Dividend per share (DPS)

The DPS is the amount the company chooses to pay out of net profit to its shareholders, expressed as a number of cents per share. The company has the choice of paying out either all of its net profit as a dividend, part of it, or none of it. It all depends on whether or not the company needs the money to fund growth or repay debt.

DPS = (TOTAL DIVIDEND PAID)/(NUMBER OF SHARES ON ISSUE)=cents per share

A good market analyst doesn’t just observe consistent dividend payment over multiple years and then decide the investment is “safe” and that the company is a “Blue chip stock”. It is very important to see if the dividends were paid from the current year’s earnings or from retained earnings from previous years. To do this you can check the payout ratio or dividends/earnings which show what percentage of earnings were paid out as a dividend. The reciprocal is earnings/dividends which is the dividend cover ratio. If the dividend cover ratio is less than one then the dividends must have been paid out of retained earnings.

Paying out all the earnings as dividends is not always a good thing, for example, a company may be able to obtain an above average return by funding expansion or acquisition instead of paying out a dividend. At other times, if the company has a surplus of cash it may pay out a special dividend or announce a return of capital.
Dividend yield

Dividend yield=DPS/(Share price)=%

A dividend yield is the dividend expressed as a percentage of the share price. This is the rate that can be used to compare the income generated from one investment to that from other investments. High dividend yields are attractive but they are a representation of past payouts. They are not a guarantee of future dividend amounts. The dividend yield figure may also be affected by fluctuating share prices.

Check our next installment of this shares fundamental analysis tutorial where we cover the Earnings per share and PE ratio.