Research Techniques

Ratios - General

These broadly fall into five categories:

  1. Ratios which measure the ability of companies to meet their current obligations - these "liquidity" ratios include the Current Ratio and Quick Assets ratio.
  2. Ratios which measure the degree of debt employed - these "gearing" ratios include Ordinary Shareholders' Equity and Interest Cover (EBIT : Interest Paid).
  3. Ratios which measure the efficiency of assets management - these "activity" ratios include stock: turnover and assets: turnover.
  4. Ratios which measure the earnings success of the business - these "profitability" ratios include the return on sales (pre-tax profit : sales), and the returns on shareholders' funds and total assets.
  5. Ratios which measure investment potential - these "investment" ratios include earnings per share (EPS), dividends per share (DPS), net tangible assets per share (NTA), cash flow per share (C/F) and the relationships of these figures to share prices.

There are no universally accepted definitions for all ratios and thus some ratios may vary slightly with calculations of the same ratios by other analysts. All ratios are computed from computerised formulae and consistently applied. Most are explained in the following sections.

Profits and Earnings

Efforts have been-made to provide a consistent basis of profit presentation, which is balanced in some instances by recognition of the fact that companies may have valid reasons for presenting figures in a different manner - which may be inconsistent with the way other companies deal with similar items.

Generally, net profit figures are more meaningful if they EXCLUDE abnormal or unusual items. Profit figures also exclude extraordinary items, a term which is not often used in accounts nowadays and when it is can be regarded as having the same meaning as abnormal or unusual items. Note that what may be considered unusual to some businesses (e.g., currency gains or losses) may not be regarded as unusual to others. Generally treated, unusual is what companies themselves deem to be unusual items.

Net profit

The declared (or calculated) net profit figure after EXCLUDING the share of profits attributable to minority interests and BEFORE deduction of earnings of associates and interest on convertible securities.

Equity Net Profit

The declared (or calculated) net profit figure, PLUS the share of earnings of associates over and above dividends received (if any).

Reported Earnings

Equity earnings (equity net profit) as reported by companies, after deduction of preference dividends, capital note interest and convertible note interest.

Normalised Earnings

Equity earnings less non-convertible preference dividends, after deduction of abnormal or unusual items (net of tax) and after deduction of amortisation of intangibles such as goodwill. Note that normalised earnings EXCLUDE profits or losses arising from assets revaluations by property companies. Note also that where convertible securities are on issue, the normalised profit figure is PRIOR to deduction of interest on the convertible securities. Thus, the normalised earnings figure represents the profits of the business which would be declared if the convertibles were not on issue. Presentation in this manner allows for accurate calculation of diluted EPS data.

Note that where capital notes are on issue, they are generally regarded as DEBT for purposes of calculations, because even though there are sometimes conversion options, these options are practically always on the proviso that companies may, at their absolute discretion, override any election to convert by holders. Convertible Notes with the same provisions attached would also be treated as debt in ratio calculations. The interest paid on such securities is included in the interest paid figure in the profit table, recognising that such securities have the same characteristics as other fixed interest securities.

Cash Earnings

Profits and non-cash expenses. Profits are deemed to exclude capital gains or other extraordinary items. The formula for calculating cash earnings is the sum of net profit, minority interests, depreciation, deferred tax provided, less the sum of unrealised development margins and dividends on non-convertible preference shares.

Profit Ratios


Tax Rate

The amount of tax provided (current and deferred), expressed as a percentage of profit before tax. From 1 April 1989, the maximum rate of company taxation reduced from 45% to 33%.

EBIT : Interest Paid (or times interest earned)

Earnings before interest and tax (EBIT), in relation to total interest paid.

Pre-tax Profit : Sales

The relationship between profit before tax, and sales turnover.

Ordinary Dividend Cover

The number of times the ordinary dividend is covered by available net profit (undiluted earnings) and cash flow (cash earnings, not diluted for convertible interest and before deduction of the ordinary dividend payment).

Dilutions and Adjustments

The primary purpose of dilutions and adjustments is to permit meaningful trends in EPS, DPS and other data to be extracted.

Dilutions are required when convertible securities are on issue. When the capital base (the number of shares on issue) is adjusted to reflect a notional conversion of the convertible securities, it is possible to calculate "fully diluted" EPS - which is diluted earnings divided by the diluted number of shares, expressed in cents per share.

Issue Adjustments require the calculation of adjustment factors when pro-rata issues to shareholders are made. These factors are applied to the historical stream of per share data, and allow valid comparisons of the data to be made.

For example, a company has the following profit history:

200019991998
Diluted Earnings ($0000)160012001000
Shares Issued (000)500040002000
EPS (historical)32.0030.0050.00

In the period, suppose the company made a 1:1 bonus issue in 1998 and a 1:4 bonus Issue in 1999. These need to be taken into account to provide valid comparisons of EPS.

200019991998
EPS (historical)32.0030.0050.00
Adjustment Factor1.000.800.40
EPS (adjusted)32.0024.0020.00

For bonus issues, the adjustment factor is calculated by the formula: old shares divided by new shares; thus, the factor for a 1:4 bonus is 4/5 or 0.80

For cash issues, the bonus element is calculated and the factor obtained is applied to the stream of data in the same way. The following (complex) formula is used for calculating this factor:

(Entitlement on 1000 * Issue Price) plus (Cum Rights Price * 1000) divided by (Cum Rights Price) * (Entitlement + 1000)

For example, assuming the following information:

  • 1:4 Issue (Entitlement on 1000 = 250) of shares at $2.00
  • Cum Rights Price: $3.00

Adjustment factor based on the above is 0.933333.

This formula is appropriate for the majority of conventional cash issues, and has the advantage of allowing factors to be calculated (and data to be updated) quickly following issue announcements and prior to rights trading.

EPS, DPS and NTA


Undiluted EPS

Undiluted earnings divided by the average number of ordinary shares on issue, expressed in cents per share. Note that the average number of shares on issue brings to account newly issued shares (for whatever purpose) on a time-weighted basis based on the month of issue. Thus, ordinary shares issued say half way through a company's financial year would be reduced by a factor of 0.50 to arrive at the average number on issue.

Diluted Equity EPS

Diluted earnings divided by the average diluted number of ordinary shares on issue, expressed in cents per share. Diluted shares on issue allow for a notional conversion of convertibles.

Diluted Issue Adjusted EPS, DPS, Cash EPS and NTA

Earnings per share, dividends per share, cash earnings per share and net tangible assets per share, diluted where appropriate, all fully adjusted for the bonus elements in issues.

Share Price Data

In the Valuation section of data files, share prices are given at the end of the company's financial year - adjusted for issues if appropriate. These are all comparable from year to year, and show meaningful perspective relating to the investment merits of each company.

P/E Ratio

The relationship between the share price and fully diluted (and issue adjusted) earnings per share. It is the number of dollars required to buy one dollar of earnings.

Price/Cash Flow Ratio

The relationship between the share price and diluted issue adjusted cash flow or cash earnings per share. It is the number of dollars required to buy one dollar of cash flow.

Pr/NTA Ratio

The relationship between the share price and diluted issue adjusted net tangible assets per share. It is the number of dollars required to buy one dollar of assets.

Historical Dividend Yield

The financial return from the investment, which relates the share price to the adjusted DPS figure.

Balance Sheet Ratios

Ratios in this section are shown for a five year period, which permits analysis of such things as the possible need for further cash injections, any change of emphasis on debt financing, or any change in returns on assets or funds.

Current Ratio

A good "rough and ready" estimate of liquidity, which expresses the relationship between current assets (assets convertible into cash within a short period) and current liabilities (obligations which fall due within a year or less). A ratio exceeding 1.00 indicates the company has more short-term assets than claims.

Quick Assets Ratio

A more precise measure of liquidity, which expresses the relationship between assets which can be converted to cash quickly (current assets less inventories), and quick liabilities (current liabilities less overdrafts). A ratio of less than 1.00 indicates an inability to meet short term liabilities immediately, although businesses seldom face such needs, and factors often exist which justify significant variations from the norm (for example, the seasonal nature of some businesses, and the cash nature of others).

Ordinary Shareholders' Equity

The proportion of total funds used in the business represented by ordinary shareholders' equity (shareholders' equity net of intangibles and preference capital). It indicates the extent to which debt financing is employed, and an equity ratio of 50% or more is generally regarded as conservative. In some sectors, however, such as finance and banking, entirely different yardsticks apply, as borrowings are the working funds and life blood of such businesses.

NTA

Net tangible assets supporting each issued ordinary share (diluted or undiluted as the case may be). Calculations of asset backing figures require allowances for such things as preference shares on issue (deducted from net assets), intangibles (deducted), convertible interest bearing securities (deducted to arrive at undiluted figures, added to arrive at diluted figures), and unpaid calls on shares (added).

Diluted Earnings to Ord. Shareholders' Equity and Total Funds

The relationship between diluted earnings and, on the one hand, ordinary shareholders' equity (shareholders' equity net of intangibles and preference capital), and on the other, total ordinary funds (total funds net of the same things). The return on total funds eliminates the effect of any gearing changes, which could influence the return on equity.