Stock Market Ratios We shall look briefly at the four ratios most commonly encountered in connection with quoted companies: earnings per share, price:earnings ratio, dividend yield, and dividend cover. Two of these - price:earnings ratio and dividend yield - are a function of a factor external to the accounts: the market price of the shares. For the purposes of this section, we shall look only at CIMA's year 2 figures, using the current mid-market price of 310p mentioned in section before. Earnings per share (EPS) The calculation is as follows: earnings attributable to ordinary shareholders over total number of ordinary shares in issue: The numerator will be the earnings after tax, minority interest and preference dividends, but before extraordinary items - the 'net' basis of EPS required by SSAP3. Adjustments must be made to the denominator for any changes in share capital during the period to which the earnings relate, and a figure for diluted EPS must be disclosed where the possible dilution exceeds 5 per cent of the basic EPS. Blake (1989) and Collier et al. (1988) provide excellent summaries of the alternatives. Price Earnings (PE) ratio The main use of EPS figures for quoted companies is as the denominator in the calculation of the PE ratio: This figure is the historic' PE ratio, i.e. based on the previous year's EPS. It is the so-called 'exit multiple' referred to in takeovers. A 'prospective' PE ratio can be calculated, using the analyst's own estimate of EPS for the current year. Obviously, any change in the share's market price will bring about a change in the multiple, historic or prospective. On the face of it, the PE ratio simply represents the number of years' historic earnings reflected in the current market price, or the capitalization of the EPS. However, this is to understate the influences which underlie the market's view of individual share prices, a topic which lies outside the scope of this book. Generally speaking, however, a high historic PE ratio compared to the section average (as set out in the FT Actuaries Indices) suggests either that the share has aboveaverage prospects (including dividend prospects) for the current year (if the market has judged it correctly), or that it is overvalued (if the judgement is flawed), or that the company is a sector leader. A PE ratio lower than the sector average suggests either that poor results are expected (if the market is right), or that it is an undervalued share if the market is wrong).