Profit and loss
A profit and loss statement shows what the company has earned during the year and how those earnings have been distributed.
The funding of dividends is also essential for investors seeking a steady income stream. Companies will usually avoid cutting dividends if they can, but if they do not make enough money, they may not have a choice.
The final bottom line is "net profit/loss attributable to members of the company", which represents the group profit or loss for shareholders.
Cash-flow
A statement of cash-flows shows where the money came from and where it went over a particular accounting period.
These statements can highlight how a company meets financial commitments, if it has the funds to continue trading, whether there are sufficient funds for expansion and if the company will require external finance in the future.
Investors should pay particular attention to three parts of a cash-flow statement, namely operating activities, investing activities and financing activities.
Balance sheet
The balance sheet is made up of assets (what the company owns), liabilities (what the company owes) and the shareholders' funds (the assets less liabilities).
Investors should compare current assets and current liabilities from this year to the last, to see whether the company could have trouble meeting its commitments.
Investors can also refer to the "company highlights" page, which can usually be found at the front of most reports and accounts. This should summarise the company’s main achievements and give an overview of its current financial position.
Six figures every investor should look for in reporting season
For investors who want to delve a little deeper into a company’s performance, here are six key ratios that could offer an insight into its potential.
1. Dividend yield
The dividend yield relates the annual dividend income per share, paid out by a company, to its market share price. It therefore reflects how much income an investor receives for each pound invested.
Dividend yield = net dividend income per share / market share price
For example, if a company declares a net dividend of 2.5p per share and its share price is 100p, then the dividend yield will be 2.5 / 100 = 2.5 per cent.
2. Dividend cover
Dividend cover relates a company’s earnings (net profit after tax) to the net dividend paid to shareholders. It therefore reflects the number of times a company’s profit covers the ordinary dividend.
Dividend cover = net earnings per share / net dividend per share
For example, if a company has earnings per share at 5p and it pays out a dividend of 2.5p, the dividend cover will be 5 / 2.5 = 2.
3. Price / earnings ratio (P/E ratio or PER)
The P/E ratio, also known as the "multiple", relates the market share price to earnings per share (EPS) and reflects the price investors are prepared to pay for each pound of earnings of a company.
P/E ratio = market share price / earnings per share (net profit after tax / no. shares)
For example, for a company with a share price of 100p and EPS of 5p, the P/E ratio is 20.
A high P/R indicates that the market expects the company’s future earnings to grow higher than those of a company with a lower P/E. However, the P/E should not be considered in isolation but rather used as a tool to compare a company with others within the same industry or to compare a company’s current performance with its historical performance.
4. Price / earnings to growth ratio (PEG ratio)
The PEG ratio relates a company’s P/E ratio to its estimated future growth rate in earnings per share of the company. It is seen as a better investment tool than the P/E ratio because it considers future growth in addition to historical performance.
PEG ratio = P/E ratio / estimated future growth (expressed as a percentage)
For example, if a company with a P/E ratio of 20 is forecast a future growth rate of 15 per cent, then the PEG will be 20 / 15 = 1.33.
The lower the PEG, the less you pay for estimated future earnings; shares with a PEG of 1 or lower are considered good value. However, a PEG ratio is only as reliable as a broker’s forecast, so it therefore makes sense to consider multiple or consensus forecasts.
5. Gearing (Debt to equity ratio)
Gearing relates to the level of a company’s interest bearing debt and reflects how encumbered a company is with debt. The debt will include preference share capital and is usually expressed as a percentage.
Debt to equity = a company’s debt / equity capital
For example, if a company borrows £120m against shareholder equity of £200m, it will have a gearing of 60 per cent.
Prudent gearing ratios vary between industries. Generally, anything over 100 per cent is considered risky or highly geared.
6. Price/book ratio (P/B ratio)
The P/B ratio relates the market share price to the net asset book value per share and can be a useful tool for finding undervalued companies.
P/B ratio = market share price / net asset book value per share
For example, if a company has a book value (value of assets – value of liabilities) of £100m and 200 million shares, then each share price represents 50p of book value. If the share price is 100p then the P/B ratio is 100 / 50 = 2.
Generally, if a P/B ratio is less than 1, the shares are good value; at over 2 they are maybe overpriced. However, the usefulness of this ratio is dependent on the valuation of the assets being both accurate and current.
Sheridan Admans is investment research manager at The Share Centre. The views expressed here are his own.
