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Assessing returns on shares (Sources of information (It will be necessary…
Assessing returns on shares
Price / Value
Price is generally a monetary amount set by a required by a seller or influenced by the forces of supply and demand (in the case of shares)
Price is not necessarily the amount that the seller will actually receive, but rather the amount they would like to receive or believe they could receive
Value is subjective. 'What can I actually get for this if I resell it?'
Sources of information
It will be necessary to be able to distinguish between relevant and irrelevant information and it is important that buyers and sellers alike consider and appraise such information objective and try to be vigilant for
Any indiction that a share is under-priced
Warning signals that a share is over-priced
reasons why they should buy, sell or hold their equities
Different classes of stakeholder will require different types of information, which they will use for their own specific purposes. Investors need information to assist them with their investment decisions, whereas financial adviser and stockbrokers require up-to-date information in order to provide accordance advice to their clients
Stock exchanges
Including up-to-date share prices, reports and regulatory information
The main UK stock exchange is the LSE. Other stock exchanges include
Germany - Gruppe Deutsche Börse AG
France - Euronext Paris
USA - New York Stock Exchange (NYSE)
Japan - Tokyo Stock Exchange (TSE)
Financial information subscription service providers
Bloomberg and Reuters provide share prices covering many international markets and sectors an in the UK, share prices are updated every 15 seconds.
Information provided by Bloomberg include
Current mid market prices
The day's high and low
52 week high and low
Number of shares issues
Market capitalisation
Price / earnings ratio
Dividend yield
Company profiles
Independent financial advisers
Can provide recommendations that may turn out to be good or bad
Provide you with current prices and informed information not only for ordinary shares but also for a wide range of other financial products including pensions and tax advice
Should have access to company reports and accounts
Newspapers and other useful publications
Include recommendations, share tips, buy sell and hold advice and other well written journalistic articles
As the hard copies may already be out of date at the time of reading, they should not be used as indicators of the current market price, given that a lot can happen in 24 hours although information may include the previous day's closing price, earnings per and the price/earnings ratio
Television and radio
The internet and company web pages
Stockbrokers
Seminars and courses and lectures
Specialist investment blogs
Webinars
Annual reports and accounts
Annual reports and accounts are invaluable sources of information relating to a company’s current and future business strategies
In the UK, the Companies Act 2006 section 447 dictates the filing obligations of quoted companies
The directors must deliver annually to the registrar a copy of:
The company accounts
The directors report: a report provided by the directors of a company which is intended to provide all stakeholders with explanations and interpretations of the figures contained within the statement of comprehensive income and other matters of significance
The directors' remuneration report
The submission must also include a copy of the auditors' report relating to each of these points. The audited accounts must provide a true and fair view. If auditors have any difficulties compiling their reports, they may qualify them, which companies do not want. This may alert stakeholders to potentially difficult situations
The directors report
May provide far more information than the Companies Act 2006 requires
Intended to provide stakeholders with explanations and interpretations of the figures contained within the statement of comprehensive income.
Also highlights other matters of significance, including a review of the year's activities and the company's likely future strategic direction
The directors' remuneration report
Provides details of the directors pay and other benefits
Statement of financial position
A snapshot of a company's account balances, both assets and liabilities shown at a given date
A business may be valued according to the total of its assets minus its total liabilities
Used to ascertain inventory totals, work in progress, levels of receivables and payables
Shows whether a company is highly geared, perhaps with too much reliance on debt
Amounts shown may already be out of date because they have not been valued for some time
If assets are found to have been undervalued, this would affect the share price positively
If assets had been overvalued, there would be a negative effect on the share price
Liabilities such as loans may be understated
The value of intangibles must also be considered. The importance of marketing strategies and business acumen may be included under intangible assets
Useful indicator of what a business maybe worth if forced into liquidation. If the liquidation happens quickly, investors may receive considerably less than the stated book values for its asset
Allows investors and analysts to calculate various ratios which will be indicators of how a business is performing
Two very important ratios are
Current ratio
The ratio of current assets (including inventory) to current liabilities
Current assets / current liabilities
Show how easy it is for a company to be able to service its current liabilities with its current assets
Acid test ratio
The ratio of current assets (minus inventory) to current liabilities
Current assets - inventory / current liabilities
Show how liquid a business is using cash only balances and receivables as it may be very difficult trying to realise inventory and conversely it may not be easy for a company to settle its current liabilities when inventory is excluded. There is a very high chance that a business may fail if it cannot services its current liabilities
Statement of comprehensive income
An account that indicates whether a business made a profit or loss in a given period
Used to calculate the gross and net profits of a company
Used to compare actual with expected results
May be used
To help a business plan ahead and make adjustments to its existing strategies
As a measure of a business' relative success or failure
To calculate nay taxes due on profits which must be paid to the revenue authorities
Stock market announcements
A company may be valued by reference not only to its share price but also to its market capitalisation (total amount of outstanding shares x market price per share)
Basic supply and demand factors affect share prices and stock market announcements can have a significant positive or negative effect on share prices
The main sources of information are naturally stock markets
There are numerous organisations that make these announcements
Announcements may have a significant effect on share prices ranging from slight to dramatic
Many announcements will already have been discounted by equity traders who have correctly anticipated the information
Numerous types of stock market announcement will be made via the company and approved for release by an exchange like the LSE. These announcements will then be made available not only on the LSE website but also on the company's own website and those of specialist web providers. The classes for announcements would include
Issue of new ordinary shares
Short-Selling disclosures
Results of extraordinary general meetings
Rights issue price announcements
Board changes
Interim results
Share buy back schemes
Profit announcements
An announcement that a company's annual profits have doubled may send share prices soaring whereas an announcement that profits have halved may cause prices to crash
General announcements
Positive news about a company generally cause share prices to rise because it increases interest whereas negative press releases can cause share prices to fall to zero
Restructuring announcement
May include large scale redundancies. This can impact on share prices depending on which such a decision is made. If the decision is as the result of falling markets, reduced demand and falling profits, share prices may fall. Alternatively if as a result of this restricting there is a considerable improvement in efficient and hence profitability, share prices may rise. Restructuring decisions are often viewed by investors as buy signals for shares because the management is seen as having taken tough decisions
Share buy back announcements
Can have varying effects depending on their rationale. It will be necessary to assess the reason for a buy back and to try to interpret the message that is being sent to the market. It would be necessary to ascertain whether or not the buy back is being financed out of surplus capital or by increased debt. A buy back financed by debt will signal a change in a company's capital structure, reducing reliance on equity. Some companies may buy back shares because they consider the value of their shares is too low, but this cannot be looked at in isolation. Share buy backs may cause investors to sell their shares thus reducing the price
Principal shareholder ratios
Earnings per share ratio
The amount of net profit attributable to each single issued ordinary share after deductions including interest, tax, preference share dividends and any minority interests
It is compulsory for all UK pubic limited companies to publish quarterly reports stating their earning per share figures
The greater the number of issued shares, the less can be allocated to each individual share
The higher the EPS figure the greater the profitability of the company
The result is always expressed as a monetary amount
Net profit after interest, tax and preference share dividend and minority interests / number of issued ordinary shares
Assumptions
May or may not be calculated before any adjustment for exceptional items
May be calculated using a variety of accounting techniques
Applications
Most useful as a means of comparing and contrasting shares in public limited companies
Indicator of the health of a company
Considered the most significant ratio
Allows analysts and current and potential shareholders to compare and contrast earnings in a company year by year
Used an indicator of a company's profitability
A comparison tool between companies in the same industry / sector
Used as an indicator of a company's ability to sustain the payment of its ordinary share dividend
Used as a precursor to calculating the P/E ratio
A way to compare and contrast different companies ability to make profits
Assuming all other factors are equal between two companies, the company with the higher EPS figure will be preferred and in theory the market price of that share ought to be higher
Shareholders will be looking for a positive trend over time
A negative trend may indicate little or no growth in the shares of the company
Price/earnings ratio
A key tool for investors and analysts
Indictor of how many years' earning could be purchased with one ordinary share at the prevailing market price of that same share. Also indicates how many years it will take to recoup the current market price of a share form the current earnings attributable to the shareholders
Current market price of one ordinary share / annual earnings per share
Assumptions
The market price is the mid market price quoted at the close of business on the previous business day and is quoted ex dividend
The ratio will change on a daily basis given that market prices may fluctuate significantly
Figures can be compared year on year within the same company, with other companies or within the same sector or the market as whole. The ratio allows companies to be compared and contrasted regardless of their size
Applications
To elicit what the price of a share ought to be in relation to EPS
To show a shares relative cheapness or expensiveness
To establish what the average is for the industry and then question why it is higher or lower for a particular company
Outcomes
A low P/E figure indicates that a stock may be undervalued. It suggests that investors do not expect any earnings growth in the near future and they perhaps believe a fall in earnings in likely or the market price has already fallen and therefore the P/E ratio has fallen
A high P/E figure
tends to be associated with growth stocks
Indicates that the market price of a share is high relative to its earnings per share and possibly the market price has risen because there is an expectation or anticipation of improved earnings
Indicates that a stock may be overvalued
Suggest that the same proportion of a company profits will cost more as the earnings do not change although the market price does and indicates how much an investor is prepared to pay for a company's earnings
Limitations
Some companies using debt may have lower P/E ratios and may appear cheaper even though they have similar prices but this may mask large debts
Caution should be exercised by looking at the wider picture in order to calculate to what extent a company is financed by external capital
Dividend yield
Indicates the percentage of its earnings a company' directors are prepared to distribute to shareholders from excess revenue
Used to measure the annual gross rate of return (per ordinary share) paid to ordinary shareholders
Represents the current year's return on the shareholders' investment
Actual gross annual dividend paid per share - including interim and final instalments / current market share price as at time of dividend payment x100
Assumptions
May be calculated using either historic or projected figures
Shown as gross but paid as net
Expressed as a percentage rather than a number
Current market share price is ex dividend
Dividends are paid out of current earnings
Applications
Used by shareholders to measure the real rate of return received on their investment
Allows investors to compare and contrast the dividend received against the current market price of the share
Used to compare and contrast the level of attractiveness of those ordinary shares that actually pay dividends
Can be used to compare not only the attractiveness of ordinary shares between similar companies but also the attractiveness of different classes of investment such as corporate bonds and bank deposits
Consdierations
Should be used in conjunction with the other shareholder ratios
Well established companies tend to have higher DYs whereas younger start ups tend to have lower yields
There cannot be a dividend yield if a company does pay a dividend
A company that does make a dividend payment in a particular year is not necessarily in financial difficulty as they may be reinvesting its profits
There is a need to exercise caution with companies paying dividends above the market norm as they may have failed to meet earnings forecasts
A high yield does not necessarily mean that the shares are cheap. It can mean or imply that a dividend will be reduced or even missed in the near future. Alternatively perhaps companies are trying to attract investors
High yield is associated with high risk and for those shares where there is a high yield, there may also be a reduced dividend or even no dividend payment at all in the near future. There may also be a chance of reduced profits or even the possibility of an imminent loss
Dividend cover
Used to assess the financial health of a company and indicate the utility of the current dividend payment and the likelihood of an increase in future payments
A measure of the ability of a company to pay its ordinary shareholders a dividend and show how many times the ordinary share dividend is covered by the net profits after tax (or alternatively the number of times the net profits can pay the current ordinary share dividend)
Net profit after payment of tax and preference share dividends / total value of ordinary dividends paid and proposed
Earnings per share / dividends per share
Assumptions
If a loss is made no calculation of dividend cover can be made although some analysts provide negative figures
If no dividend payment is proposed or made, dividend cover cannot be calculated
If the earnings are greater than the dividend, dividend cover will be greater than one
If the earnings are less than the dividend, dividend cover will be less than one
Dividend cover of less than one means that a company cannot cover its dividend rom the earnings of the year in question. Investors would then need to ascertain how the dividend is actually being covered, typically this will be from previous years retained earnings
A high ratio implies that a company is retaining a considerable proportion of its earnings
Application
To relate the total dividend payments to total earnings
To show how easy it is for the company to be able to afford its dividend. The greater the amount paid out means the less available for retention
As an indictor of continued profitability
A dividend is usually paid out of the current year's earnings. However it is possible that a company can declare a dividend that exceed its net profit after taxation and preference share dividend. In this case, payment would typically be made from previous years' retained earnings
Indicators
Should not be viewed in isolation and investors should consider the norm for the industry sector
Low dividend cover implies that a company is not retaining sufficient funds within the company - perhaps investment is too low. If the company's fortunes were to take a sudden downturn, it might not be able to maintain its current dividend payments or might even have to reduce future payments
High dividend cover implies that a company is retaining a considerable proportion of its earnings and may indicate that a company could have paid out more in dividends. However the directors have decided to retain more for future investment
Where a company pays out a dividend greater than its earnings, the dividend is said to be either uncovered or not fully covered which in certain circumstances will be acceptable to investors. Generally ratios tend to be at least 2:1 but there is considerable variation and indeed a cover of at least two implies that a company has sufficient funds to maintain its dividend
Income investors will want a low level of cover as they will want larger dividend payments whereas investors seeking capital growth will want a higher cover because of retained earnings