Essential Financial Formulas Every UK Retail Investor Should Know
1. Price-to-Earnings Ratio (P/E Ratio)
P/E Ratio = Market Price per Share / Earnings per Share (EPS)
Example: Tesco PLC
Suppose Tesco's stock price is £3.07, and its EPS is £0.23. The P/E ratio would be:
3.07 / 0.23 = 13.34
Historical Context:
In early 2007, Barclays PLC had a stock price of around £7.90. During the financial crisis, by January 2009, the stock price had plummeted to approximately £1.20. At the same time, Barclays' earnings per share (EPS) were around £0.30.
This P/E ratio of 4 was significantly lower than the historical average for Barclays and much lower than the P/E ratios of many of its peers in the banking sector, which often ranged from 10 to 15 during more stable economic periods. This stark drop in the P/E ratio was a strong signal to some investors that Barclays was undervalued.
The P/E ratio is a critical measure of how much investors are willing to pay for each pound of earnings. A higher P/E ratio suggests that investors expect higher future growth, while a lower P/E ratio could indicate a potentially undervalued stock or a company in decline.
2. Dividend Yield
Dividend Yield = (Annual Dividends per Share / Price per Share) * 100
Example: BP PLC
If BP’s annual dividend is £0.22 and the stock price is £4.89, the dividend yield would be:
(0.22 / 4.89) * 100 = 4.49%
Historical Context.
In the mid-2010s, BP offered high dividend yields as it worked to recover from the financial impacts of the Deepwater Horizon spill. This high yield attracted income-focused investors looking for steady returns in a low-interest-rate environment.
The Deepwater Horizon spill in 2010 had a significant financial impact on BP, resulting in substantial cleanup costs, legal fees, and settlements. Despite these challenges, BP maintained its commitment to returning value to shareholders through dividends.
This dividend yield of approximately 6.44% was notably high, especially in comparison to the yields offered by other companies in the same sector and the broader market. For context, the average dividend yield for the FTSE 100 companies was around 3-4% during this period.
Dividend yield is essential for investors seeking regular income from their investments. It represents the return a company pays out to its shareholders in the form of dividends relative to its share price.
3. Return on Equity (ROE)
ROE = (Net Income / Shareholders' Equity) * 100
Example: Unilever PLC
If Unilever's net income is £7.14 billion and shareholders' equity is £25.8 billion, the ROE would be:
(7.14 / 25.8) * 100 = 27.67%
Historical Context:
In the late 1990s, GlaxoSmithKline (GSK) exhibited a high Return on Equity (ROE), reflecting its strong profitability and efficient use of shareholders' equity. This high ROE signified GSK's ability to generate significant profits from its equity base.
The high Return on Equity (ROE) achieved by GlaxoSmithKline (GSK) in the late 1990s was indicative of the company's robust market position. This period was marked by successful product launches, substantial investments in research and development (R&D), and strategic mergers and acquisitions, which collectively fueled GSK's profitability and efficiency in using its shareholders' equity.
During this time, GSK's shareholders' equity increased significantly. For instance, it grew from approximately £3.05 billion in 1997 to around £5.08 billion by the end of 1999
This growth in equity, combined with strong net income driven by blockbuster drugs, reinforced GSK's high ROE, enhancing investor confidence in the company's ability to sustain its growth trajectory.
ROE is a measure of financial performance, indicating how effectively a company uses its equity to generate profit. A high ROE is generally a positive sign of financial health and operational efficiency.
4. Earnings per Share (EPS)
EPS = (Net Income - Dividends on Preferred Stock) / Average Outstanding Shares
Example: HSBC Holdings
If HSBC's net income is £24.56 billion and it has 3.8 billion shares outstanding, the EPS would be:
24,000,000,000 / 3,880,800,000 = £6.18
Historical Context:
In 2012, Lloyds Banking Group experienced a substantial improvement in its earnings per share (EPS), which rose significantly from the levels seen during the 2008 financial crisis. This increase in EPS was a clear indicator of the bank's enhanced profitability and financial health. The positive shift was a crucial sign for investors, suggesting that the bank was on a stable path to recovery and had managed to overcome some of the major financial challenges it faced in the past few years.
EPS is a vital indicator of a company's profitability on a per-share basis. It helps investors understand how much profit a company generates for each share of stock, making it easier to compare companies within the same industry.
5. D/E Ratio = Total Liabilities / Shareholders' Equity
D/E Ratio = Total Liabilities / Shareholders' Equity
Example Vodfhone
If Vodafone has total liabilities of £36 billion and shareholders' equity of £67 billion, the D/E ratio would be:
36 / 67 = 0.537
Historical Context:
Throughout the 2000s, Vodafone Group maintained a significantly high debt-to-equity (D/E) ratio, largely due to its extensive series of acquisitions. At one point, the D/E ratio escalated to over 1.5, reflecting a high level of indebtedness relative to its equity. This indicated that the company was operating with considerable leverage, which represented a potential risk factor if not strategically managed. The elevated D/E ratio required careful financial oversight to mitigate any adverse impacts on the company’s stability and to maintain confidence among investors and stakeholders.
The D/E ratio is a measure of a company's financial leverage. It indicates how much debt a company is using to finance its assets relative to the value of shareholders' equity. A higher D/E ratio can imply greater risk, especially in volatile markets, but it can also indicate potential for higher returns.
Which formula do you use the most?
Thanks for reading,
Ollz
