The first commonly used indicator of share performance is the dividend yield. Take the example of a stockmarket-listed company, ABC plc, which has a current share price of 2 and pays a dividend of 10p a year. This represents a dividend yield of 5 per cent.It is perhaps tempting to compare these yields with the returns on cash deposits and fixed-interest securities. I would suggest that a more pertinent figure is the earnings per share. ABC plc has made profits of 20m in the last reporting year. With 40 million issued shares, this represents an earnings per share of 50p (the annual profit divided by the number of shares in issue). What happens to the missing profit of 40p per share, that is, the difference between the 50p profit and the 10p payment to shareholders? Clearly, this profit – often termed undistributed profit – has been retained within the company, usually to fund further expansion. Now let us move on to the dividend cover ratio. ABC plc’s profit of 50p per share with a dividend of 10p per share represents a dividend cover ratio of five. At this stage, it is perhaps useful to contrast ABC plc with XYZ plc. XYZ also paid a dividend of 10p last year but only had earnings of 5p per share, giving a dividend cover ratio of only 0.5. Such dividend payments are clearly unsustainable unless profits increase in the coming years. This leads us back to the earnings per share ratio. Put in simple terms, the eps ratio is the annual profit divided by the number of shares in issue. Alternatively, the eps can be expressed as the dividend yield multiplied by the dividend cover ratio. Which indicator is most important? On the one hand, the dividend yield is the most obvious indicator as it might seem to give the best comparison with yields from other asset classes. However, if a certain level of dividend seems unlikely to be sustained in future years, past performance might prove to be far from indicative of future returns. Moving on to look at the market as a whole rather than individual shares, the FTSE Actuaries share indices are crucial when working towards projections of future performance. Taking the FTSE 100 index first, at a current level of 5,500, the average dividend yield is 3.15 per cent. This compares reasonably well with a typical deposit rate of interest. But the same index has a dividend cover of 2.3, indicating an earnings per share of 7.245 per cent (the dividend payment multiplied by the dividend cover). I would suggest that this is a more important indicator of long-term returns from equities but it is by no means the end of the matter as these indicators only show past performance. Each week, the Financial Times summarises the dividend payments and profitability of all listed companies reporting in the previous week. I find it useful to spend a couple of minutes working out the continuing trends. For many years now, I have noted a consistent increase in profitability and dividend payments – not for every company, of course, but for reporting companies in total. Could it be suggested that the following statistics are relevant for equity investors?
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