In simple terms
A friendly intro before the formal notes — no formulas yet.
Investment ratios
9609 A Level — dividend yield, dividend cover, P/E ratio, and shareholder analysis.
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Used primarily by external shareholders to evaluate investment potential.
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Focus on returns (dividends, capital gains) and market perception.
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Enable comparison between different companies or against industry averages.
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Key ratios include Dividend Yield, Dividend Cover, and the Price/Earnings (P/E) Ratio.
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Key formulas
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At a glance — side by side
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Shareholder Ratio Analysis: Mature PLC vs. Growth PLC
| Ratio | Company A (Mature PLC) | Company B (Growth PLC) | Interpretation for Shareholders |
|---|---|---|---|
| Dividend Yield | 5.5% | 0.8% | Company A offers a high immediate return, attractive for income-seeking investors. Company B provides a low income return, as it retains profits for growth. |
| Dividend Cover | 2.1x | 9.5x | Company A's dividend is secure and sustainable. Company B could easily pay a much higher dividend but chooses to reinvest heavily, making its current small dividend extremely safe. |
| P/E Ratio | 12 | 45 | The market has low growth expectations for Company A, valuing it as a stable income provider. The market has very high growth expectations for Company B, paying a premium for anticipated future profits. |
| Investor Profile | Retirees, pension funds, income investors. | Growth-focused investors, venture capitalists, those with a long-term investment horizon. | The ratios guide different types of investors to the company that best matches their financial objectives (income vs. capital appreciation). |
Dividend Yield
Company A (Mature PLC)
Company B (Growth PLC)
Interpretation for Shareholders
Dividend Cover
Company A (Mature PLC)
Company B (Growth PLC)
Interpretation for Shareholders
P/E Ratio
Company A (Mature PLC)
Company B (Growth PLC)
Interpretation for Shareholders
Investor Profile
Company A (Mature PLC)
Company B (Growth PLC)
Interpretation for Shareholders
Full topic notes
Formal explanation with the rigour you need for the exam.
Understanding Investment Ratios
Investment ratios, also known as shareholder ratios, are financial metrics used by existing and potential shareholders to assess the performance and attractiveness of an investment in a public limited company (plc). Unlike profitability or liquidity ratios which are primarily for internal management or lenders, these ratios focus on the returns and market value associated with shares. They help investors to compare the performance of different companies, understand the return on their investment in the form of dividends and share price appreciation (capital gains), and evaluate the risk associated with a company's dividend policy and market valuation. These ratios are crucial for making informed investment decisions, as they provide a snapshot of market confidence and the sustainability of shareholder returns.
Used primarily by external shareholders to evaluate investment potential.
Focus on returns (dividends, capital gains) and market perception.
Enable comparison between different companies or against industry averages.
Key ratios include Dividend Yield, Dividend Cover, and the Price/Earnings (P/E) Ratio.
Dividend Yield
The dividend yield ratio measures the annual dividend per share as a percentage of the current market price of that share. The formula is: (Dividend per share / Market price per share) x 100. A higher dividend yield suggests a greater cash return on the investment for the shareholder. However, context is vital. A very high yield could be a warning sign, potentially caused by a rapidly falling share price, which indicates a lack of market confidence. Conversely, a low yield might be found in a 'growth' company that reinvests most of its profits for expansion, promising future capital gains instead of immediate income. Investors often compare a company's dividend yield to the interest rates available from a bank to assess its relative attractiveness as an income-generating asset.
Formula: (Dividend per share / Market price per share) x 100.
Indicates the percentage return on a share's price from dividends alone.
A high yield may attract income-seeking investors but can also signal risk.
A low yield is typical for growth companies reinvesting profits.
In an exam, when analysing dividend yield, always consider the trade-off between dividend income and potential capital growth. A company with a low yield isn't necessarily a poor investment if it is successfully reinvesting profits to increase its future value and share price.
Dividend Cover
Dividend cover measures a company's ability to pay its declared dividends to shareholders from its post-tax profits. The formula is: Profit for the year / Annual dividends. This ratio reveals the sustainability of the dividend payments. A dividend cover of 2, for example, means that the company's profits are twice the amount of the dividend payout. A low cover, especially if it is below 1.5, is a significant concern as it suggests the company is paying out a large proportion of its earnings, leaving little for reinvestment or to absorb a future fall in profits. A cover below 1 indicates the company is using retained profits from previous years to fund the dividend, which is unsustainable. A healthy cover provides confidence that dividend payments can be maintained.
Formula: Profit for the year / Annual dividends.
Assesses the sustainability of dividend payments from current profits.
A cover of around 2 is often considered a safe and prudent level.
A cover below 1.5 is a warning sign; below 1 is unsustainable.
Price/Earnings (P/E) Ratio
The Price/Earnings (P/E) ratio is a key valuation metric that compares a company's current share price to its earnings per share (EPS). The formula is: Market price per share / Earnings per share. In essence, it shows how much investors are willing to pay for each pound of a company's earnings. A high P/E ratio often indicates that the market has high expectations for future earnings growth, and investors are willing to pay a premium for that potential. Technology companies frequently have high P/E ratios. Conversely, a low P/E ratio might suggest a mature company with stable but slow-growing earnings, or it could indicate that the company is undervalued by the market. It is most useful when compared over time or against other companies in the same industry.
EPS =
Dividend yield =
Dividend cover =
P/E ratio =
Formula: Market price per share / Earnings per share (EPS).
Reflects market confidence and expectations of future growth.
A high P/E suggests expectations of strong future earnings growth.
A low P/E may indicate an undervalued company or low growth prospects.
Avoid stating that a high P/E ratio is simply 'good' or a low one is 'bad'. A high P/E ratio represents high expectations, which also means high risk if the company fails to deliver the expected growth. Analysis must always be in context.
Worked examples
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2 million shares in issue. Profit for the year $5 m; 40% paid as dividend. Share price $4.00.
Calculate EPS, DPS, dividend yield, dividend cover, and P/E.
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EPS = 5 000 000 ÷ 2 000 000 = **
An investor is choosing between two companies. Tech Innovate plc is a fast-growing technology firm. Stable Utilities plc is a mature company in the energy sector. Their financial data is below:
| Metric | Tech Innovate plc | Stable Utilities plc |
|---|---|---|
| Share Price | $150.00 | $40.00 |
| --- | --- | --- |
| Profit for the year | $50,000,000 | $100,000,000 |
| Number of shares | 10,000,000 | 50,000,000 |
| Total dividends paid | $5,000,000 | $60,000,000 |
Calculate the EPS, DPS, Dividend Yield, Dividend Cover, and P/E Ratio for both companies. Advise an investor seeking a steady income on which company to invest in.
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1. Calculations for Tech Innovate plc:
- EPS: $50,000,000 / 10,000,000 shares = $5.00
- DPS: $5,000,000 / 10,000,000 shares = $0.50
- Dividend Yield: (150.00) x 100 = 0.33%
- Dividend Cover: 0.50 = 10 times
- P/E Ratio: 5.00 = 30
How it all connects
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Glossary
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Revision flashcards
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Dividend per share (DPS)?
Total dividend paid ÷ Number of shares in issue.
Key takeaways
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- ✓
Used primarily by external shareholders to evaluate investment potential.
- ✓
Focus on returns (dividends, capital gains) and market perception.
- ✓
Enable comparison between different companies or against industry averages.
- ✓
Key ratios include Dividend Yield, Dividend Cover, and the Price/Earnings (P/E) Ratio.
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