We need to understand the tools, ratios and techniques used by investment analysts - 'City' ratios as well as established accountants' ratios. These performance measures are focused on measuring the performance of a company in relation to other listed or quoted companies. That is, how does it perform in relation to the market?
The following terms and ratios are the principal ones used when considering stock market performance.
There are three shares values commonly quoted: nominal (par) value, book (asset) value and market value.
1 Nominal (par) value. The nominal value is largely a notional low figure arbitrarily placed on a company's stock. It serves to determine the number for 'issued share capital' or 'issued common stock'.
2 Book value. This value is arrived at by dividing the number of issued shares into the shareholders' or stockholders' funds or equity.
3 Market value. This is the price quoted in a stock exchange for a public company or an estimated price for a non-quoted company. On the stock exchange the figure changes daily in response to actual or anticipated results and overall sentiment of the market.
Earnings per share (EPS)
'Earnings per share' is one of the most widely quoted performance measures when there is a discussion of a company's performance or share value. The profit used in the calculation is the profit available to shareholders after all other claimants have been satisfied. The most common prior charges in the P&L account are interest and tax.
The profit is divided by the number of issued shares to calculate the value of EPS. This figure tells us what profit has been earned by the shareholder for every share held. There is GAAP: specific accounting standards which further define profit and number of shares as it may be possible to manipulate these figures.
One important piece of additional information is that the 'fully diluted' EPS should be shown. Fully diluted means that if all options on shares, to directors, employees or those holders of loans which can be converted into ordinary shares were taken up, then obviously the number of shares in existence would increase and the EPS figure would fall. A much lower fully diluted EPS figure indicates many options in existence or a high level of convertible loans.
Below is an extract from IMI accounts explaining their calculation of EPS.
IMI pic EPS
Basic EPS increased 14.9 per cent to 72.6p (2011: 63.2p) and diluted EPS was 71.6p (2011: 62.1 p). The Board considers that a more meaningful indication of the underlying performance of the Group is provided by earnings before charging/(crediting) exceptional items after-tax. Details of this calculation are given in note 8 to the Group financial statements. On this basis the adjusted EPS from continuing operations was 84.3p, an increase of 3 per cent over last year's 81.5p. The revision to I AS 19 'Employee Benefits' will apply to the Group from 1 January 2013. The principal effect on the Group of the revisions to this standard is to change the basis for the calculation of the return on assets reported as financial income in the Group's income statement, whereby the amount reported in the income statement is reduced and the amount reported in other comprehensive income is increased by an equivalent amount. Had this change been effective for the year ended 31 December 2012, we estimate that the net finance income reported of £11.0m would have been a net finance charge of £7.8m, which after tax, would have resulted in a 4.6p reduction in basic and adjusted earnings per share. The equivalent finance charge is estimated at£8m for 2013.
It may be that humans simply take in headline figures, of which EPS is one. I have always thought that there is an over-emphasis on this measure; an intelligent investor will look into results in much more depth. But we are but human and thus, as with IMI, companies have to spell out what the underlying operational figures are, making allowance for one-offs or accounting changes.