VALUATION RATIO

This ratio indicates the growth potential of the firm in addition to determining the value of the firm and investment made by various investors. They include the following:

a) Earnings per share EPS = Earnings to Ordinary shareholders

No. of ordinary shares

This ratio indicate earnings power of the firm i.e how much earnings or profits are attributed to every share held by an investor. The higher the ratio the better the firm.

b) Earnings yield (EY) = Earnings per share x 100

Market price per share

The market price per share (MPS) is the price at which new shares can be bought from the stock market.

• These ratios therefore indicate the returns or earnings for every one shilling invested in the firm.

c) Dividends per share (DPS) = Dividend paid

No. of ordinary shares

- This indicates the cash dividend received for every share held by an investor. If all the earnings attributable to ordinary shareholders were paid out as dividend, then EPS = DPS.

d) Dividend Yield (DY) = Dividend per share x 100

Market price per share

Or Dividend paid

Market value of equity

Where market value of equity = No. of shares x MPS

This ratio indicates the cash dividend returns for every one shilling invested in the firm.

e) Price earnings (P/E) = Market price per share (MPS)

Ratio Earning per share

OR

= Market value of equity

Earning to Ord. Shareholders

P/E ratio is a reciprocal of earning yield (EY). The MPS is the price at which a new share can be bought i.e investment per share. The EPS is the annual income/earnings from each share.

• PE therefore indicate the payback period i.e number of years it will take to recover MPS from the annual earnings per share of the firm.

f) Dividend cover = EPS = Earning to ordinary shares

DPS Dividend paid

This indicate the number of times dividend can be paid from earnings to ordinary shareholders. The higher the DPS the lower the dividend cover and vice-versa e.g consider the following two firms X and Y

X                        Y

EPS           12/=                12/=

DPS            3/=                 5/=

Dividend cover 12 = 4 12 = 2.4 times

3                     5

g) Dividend pay out ratio = DPS x 100 = Dividend paid

EPS Earning to ordinary shareholder

This is the reciprocal of dividend cover. It indicates the proportion of earnings that was paid out as dividend e.g a payout ratio of 40% means 60% of earnings were retained while 40% was paid out as dividend, therefore retention ratio = 1 – dividend payout ratio

h) Book value per share = Networth Equity

(BVPS) No. of ordinary shares

This is also called liquidity ratio which indicates the amount attributable to each share if the firm was liquidated and all asset sold at their book value.

• The ratio is based on the residual amount which would remain after paying all liabilities from the sales proceeds of the assets.

i) Market to book value per share = MPS

BVPS

• This ratio indicates the amount of goodwill attached to the firm i.e the price in excess of the sales value of the assets of the firm. If the ratio is greater 1(MBVPS >1) this indicate a positive goodwill while if less than 1 a –ve goodwill.