Company performance ratios to help you assess company potential
Financial ratios can be incredibly useful for deciding whether and when to buy shares. You can view them on our company overview pages or in annual reports; but what do they mean?
Dividend yield reflects how much income investors receive for each pound invested, but it should not be considered in isolation.
A low dividend yield could indicate a high share price, due to positive growth prospects, or it could mean the company can’t afford to pay a decent dividend. Conversely, a high dividend yield may provide a dividend that lessens the impact of any fall in share price, but it could raise concerns over prospects.
Dividend yield = Net dividend income per share / Market share price
Dividend cover reflects the number of times a company’s profit covers the ordinary dividend. Generally, a ratio of 2 or higher is considered safe, with anything below 1.5 being risky.
At 1, a company’s profits are only just covering dividends. Under 1, dividends are being paid from retained earnings, which is normally not sustainable.
Dividend cover = Net earnings per share / Net dividend per share
The P/E ratio reflects the price investors are prepared to pay for each pound of company earnings. A high ratio indicates that the market expects future earnings to grow quicker than a company with a low P/E. It should be used to compare with historical performance or companies in the same industry.
P/E ratio = Market share price / Earnings per share
The price/earnings to growth ratio (PEG ratio) is seen as a better investment tool than the P/E ratio because it considers future growth, in addition to historical performance.
Shares with a PEG of 1 or lower are considered good value (the lower the PEG, the less you pay for estimated future earnings). However, it is only as reliable as the estimated growth forecast.
PEG ratio = P/E ratio / Estimated future growth
Gearing reflects to what extent a company is encumbered with debt. Anything over 100 is considered risky, but it varies between industries.
Gearing ratio = A company’s debt / Market Capitalisation
The price-to-book ratio can be a useful tool for finding undervalued companies. Anything under 2 is considered good value (over 2 may be overpriced). It relies on the valuation of assets being accurate and current.
P/B ratio = Market share price / Net asset book value per share