Analysis Of Published Accounts: Investment Ratios (Copy)

10.2 Accounting Ratios

10.2.5 Investment Ratios

1. Meaning and Importance of Return to Investors

• Return to investors: Measures the financial benefit shareholders receive from investing in a business.
• Importance:
  • Helps investors assess profitability and attractiveness of investing.
  • Guides business decisions on dividends, share price strategy, and growth.
  • Indicates overall performance relative to shareholder expectations.

2. Key Investment Ratios

a) Dividend Yield

• Formula:
  Dividend Yield (%) = (Dividend per Share ÷ Market Price per Share) × 100
• Interpretation:
  • High yield → attractive income for shareholders.
  • Low yield → less income, may indicate reinvestment in growth.
• Example:
  • Dividend per Share = $2
  • Market Price = $40
  • Dividend Yield = (2 ÷ 40) × 100 = 5% ✅

b) Dividend Cover

• Formula:
  Dividend Cover = Profit after Tax ÷ Total Dividends Paid
• Interpretation:
  • High cover → sustainable dividend, retained profits available for growth.
  • Low cover → dividend may be at risk if profits fall.
• Example:
  • Profit after Tax = $500,000
  • Dividends Paid = $200,000
  • Dividend Cover = 500,000 ÷ 200,000 = 2.5 ✅

c) Price/Earnings (P/E) Ratio

• Formula:
  P/E Ratio = Market Price per Share ÷ Earnings per Share (EPS)
• Interpretation:
  • High P/E → investors expect future growth.
  • Low P/E → undervalued or lower growth expectations.
• Example:
  • Market Price = $50
  • EPS = $5
  • P/E Ratio = 50 ÷ 5 = 10 ✅

3. Methods of Improving Investor Return

• Increase profits: Grow revenue, reduce costs.
• Pay consistent or higher dividends: Improve dividend yield.
• Increase earnings per share (EPS): Buyback shares, reduce share capital.
• Improve market perception: Promote growth potential, innovation, and sustainability.

Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change A2 Level Business Full Scale Course