Investment Ratios (Stock Exchange Ratios) (Cambridge International A-Level Accounting)

What are investment ratios?

• Investment ratios measure the efficiency, profitability, or valuation of an investment

  • They compare the profit to its cost, or the share price to its earnings

• You need to know the following investment ratios:

  • Earnings per share
  • Price/earnings ratio
  • Dividend per share
  • Dividend yield
  • Dividend cover

Earnings per share & price/earnings ratio

Spec point — how to calculate the following ratios: – earnings per share

• price/earnings ratio

Earnings per share & price/earnings

What is earnings per share?

• Investors look for companies with high earnings per share

  • This is because the company has more profits to potentially pay dividends

What is the price/earnings ratio?

• If the price/earnings is high

  • The market expects strong future growth
  • Investors are willing to pay a premium

• If the price/earnings is low

  • The market has lower expectations
  • Shares might be undervalued or the company is declining

Worked Example X plc has provided the following information for the year ended 31 December 2025.

	$
Ordinary share capital ($1.50 shares)	600 000
Share premium	50 000
Retained earnings	44 000

• An interim dividend of $0.14 per share was paid on 1 October 2025.
• The balance of the retained earnings at 1 January 2025 was $40 000.
• No additional shares were issued during the year.
• The market price per share at 31 December 2025 was $3.55.

Calculate, to two decimal places:

(i) the earnings per share

(ii) the price/earnings ratio.

Answer:

(i)

• Calculate the number of shares

\frac{\ 600 000}{$ 1.50} = 400 000$

• Calculate the total interim dividend payment

400 000 \times \ 0.14 = $ 56 000$

• Calculate the profit for the year

  • Subtract the opening balance from the closing balance of the retained earnings
  • Add the dividend paid

	$
Retained earnings at 31 Dec 2025	44 000
Retained earnings at 1 Jan 2025	(40 000)
Dividend paid	56 000
Profit for the year	60 000

• Calculate the earnings per share

  • $\frac{\mathrm{Profit} \mathrm{for} \mathrm{the} \mathrm{year}}{\mathrm{Number} \mathrm{of} \mathrm{issued} \mathrm{ordinary} \mathrm{shares}}$

$\frac{60000}{400000}=0.15$

Final answer: $0.15 per share

(ii)

• Calculate the earnings per share

  • $\frac{\mathrm{Market} \mathrm{price} \mathrm{per} \mathrm{share}}{\mathrm{Earnings} \mathrm{per} \mathrm{share}}$

$\frac{3.55}{0.15}=23.666666...$

• Round to two decimal places

Final answer: 23.67 times

Dividend per share & dividend yield

Spec point — how to calculate the following ratios: – dividend per share – dividend yield

Dividend per share & dividend yield

What is dividend per share?

• You can split the calculation into two calculations

  • One for the interim dividend payment
  • One for the proposed final dividend

• The exam question might give you one of them and ask you to find the other

  • Just make sure to check how many shares are issued

Exam Hint Be careful to only include dividends relating to the financial year. Sometimes during the year, the final dividend for the previous year is paid. This would affect the statement of changes in equity, but this does not affect this ratio.

What is dividend yield?

• Investors look for companies which have a higher dividend yield

  • However, if the yield is very high, then this can signal that the share price has fallen rapidly

    • There could be concerns about the company

• If the dividend yield decreases, then:

  • the share price might have increased faster than the dividends
  • or the dividends might have been cut

Worked Example Y plc has provided the following information for the year ended 31 December 2025.

	$
Ordinary share capital ($2 shares)	1 000 000

• A final dividend of $0.12 per share for 2025 was proposed at the year end. Dividends paid during the year comprised a final dividend of $90 000 for 2024 and an interim dividend of $80 000 for 2025.
• No additional shares were issued during the year.
• The market price per share at 31 December 2025 was $4.25.

Calculate, to two decimal places:

(i) the dividend per share

(ii) the dividend yield.

Answer:

(i)

• Calculate the number of shares

\frac{\ 1 000 000}{$ 2} = 500 000$

• Calculate the dividend per share for the interim dividend

\frac{\ 80 000}{500 000} = $ 0.16$

• Add this to the proposed final dividend per share for 2025

  • Ignore the final dividend for 2024

$ 0.16 plus $ 0.12 equals $ 0.28

Final answer: $0.28 per share

(ii)

• Calculate the dividend yield

  • $\frac{\mathrm{Dividend} \mathrm{per} \mathrm{share}}{\mathrm{Market} \mathrm{price} \mathrm{per} \mathrm{share}}\times100$

$\frac{0.28}{4.25}\times100=6.588235...$

• Round to two decimal places

Final answer: 6.59%

Dividend cover

Spec point — how to calculate the following ratios: – dividend cover

Dividend cover

What is dividend cover?

• This ratio indicates the sustainability of the dividend and how much profit is being retained

  • If it is above 2 times

    • It is sustainable as substantial profit is being retained after the dividend

  • If it is around 1.5 to 2 times

    • It is an acceptable level

  • If it is below 1 times

    • It is unsustainable in the long run as the dividend is being paid out of the reserves

Why might directors want to increase dividend cover?

• Increasing dividend cover means retaining more profit in the business
• Retained profit can be used for business expansion without the need for additional borrowing
• If the company has a higher dividend cover, then it can maintain dividend levels even if profits fall in future years
• Directors want assurance that the business can sustain the current dividend level going forward

Worked Example Z plc has provided the following information for the year ended 31 December 2025.

	$
Ordinary share capital ($1.50 shares)	750 000
Profit from operations	180 000
Profit for the year (after interest and tax)	120 000

• A final dividend of $0.11 per share for 2025 was proposed at the year end.
• An interim dividend of $0.10 per share was paid in October 2025.
• No additional shares were issued during the year.
• The market price per share at 31 December 2025 was $4.25.

Calculate, to two decimal places, the dividend cover.

Answer:

• Calculate the number of shares

\frac{\ 750 000}{$ 1.50} = 500 000$

• Calculate the annual ordinary dividend paid

$ 0.11 + $ 0.10 = $ 0.21 per share > $ 0.21 x 500 000 = $ 105 000

• Calculate the dividend cover

  • $\frac{\mathrm{Profit} \mathrm{for} \mathrm{the} \mathrm{year} \mathrm{available} \mathrm{to} \mathrm{pay} \mathrm{ordinary} \mathrm{dividend}}{\mathrm{Annual} \mathrm{ordinary} \mathrm{dividend}}$

$\frac{120000}{105000}=1.142857...$

• Round to 2 decimal places

Final answer: 1.14 times