This is a ratio of profits available for ordinary shareholders expressed as a multiple of the total dividends paid and payable. It can also be found by dividing EPS by DPS:
- A high cover suggests that the dividend is fairly safe, because it can be maintained in the face of any expected downturn in profit.
- A high cover also indicates a high retention policy, which suggests that the company is aiming for growth.
Earnings yield and dividend yield
The yield on a share can be expressed as the return it provides in terms of earnings or dividends as a percentage of the current share price.
The earnings yield shows the relationship that EPS bears to the share price. For instance, if the EPS is 1.50 and the share price is 10.00, the earnings yield is 15 per cent. If the share price moved up to 15.00, the corresponding yield would be 10 per cent. A low yield generally indicates a share that is in demand from investors.
Table 7.15 shows a dividend note from Accor.
TABLE 7.15 Accor - dividend payout
SOURCE: Accor (2012)
Operating profit before non-recurring items has been selected as presumably this gives a better indicator of future profit trend. The dividend per share and payout ratio (50 per cent of what are considered normal profits) means a dividend cover of 2:1. This would seem a sensible amount for a business in a stable but growing sector. Note that in 2011 there was a special dividend.
Price to earnings ratio (P/E ratio)
The P/E ratio is a widely quoted measure of share value. The share price is divided by the EPS figure.
A company has no direct control over the P/E ratio. In the long term, however, it must deliver a good return to the equity shareholders to secure a continued high rating.
The advantages of a high P/E ratio value are considerable. New funds can be raised at a favourable price. The company has the means to make acquisitions on favourable terms by using its 'paper' (shares), as opposed to cash.
As with other 'City' ratios or measures, P/E ratios are often used simplistically or ignorantly. Examples are company valuations. An utterly crude method of valuation is to take a company's earnings and multiply by the market's average P/E ratio. This does indeed give a market valuation. But is the company being valued really typical of the sector, and what about the fickle market?
Sillier still is the valuation of private companies where the listed P/E ratio is often halved to give the multiple for valuation purposes.
Having made these points, in stable markets with pedestrian companies, the P/E ratios do indicate the market's view of value.
Market to book ratio
The ratio relates the total market capitalization (number of issued shares times the market price) of the company to the shareholders' book, that is, financial statements' funds or equity.
It is the investors' perception of the performance of the company in terms of profits, balance sheet strength or liquidity and growth that determines this ratio.
A value of less than 1 means that the shareholders' investment has apparently diminished in value but may really indicate that the market does not appreciate true value.
Earnings before interest, tax, depreciation and amortization. All the rage -quite why? The only explanation is that at least this figure of 'profitability' is not distorted by accounting sleight of hand! It is nearer to a figure of gross cash generation.
Accor gives us an example of the fact that we need to be sure as to what people mean by EBIT and EBITDA - there are clear definitions but they are open to further defining, as shown in Table 7.16.
TABLE 7.16 Accor – EBIT
EBIT, corresponding to EBITDAR after depreciation, amortization, provisions and rental expense, improved by 3.0% like-for-like to €526 million from €515 million in 2011. The increase may be analyzed as follows:
(1) At constant scope of consolidation and exchange rates. SOURCE: Accor (2012)
City ratios are important, but it is internal ratios that help you run the business.
Every book on finance, notes for MBA students etc trip out the old favorites with respect to ratios. There are fads as to what is important; also, there are very good reasons that at some point one ratio takes precedence - eg chasing sales - but it is important that readers understand the hierarchy of the ratios and their interaction to help them deliver strategy.