Financial Strategy Wk 7

Paul Hammett
e-mail: paul.hammett@staffs.ac.uk

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 Week 7 Learning
Outcomes
 understand what is meant by short-
termism in businesses
 understanding the key investment ratios
in the financial pages
 be able to apply the key stock
market and investor ratios

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 Short-Termism
 Short-termism refers to an excessive focus on
short-term results at the expense of long-term
interests.
 It is often argued that excessive short-term focus
by some corporate leaders, investors, and analysts
combined with insufficient regard for long-term
strategy can tip the balance in value-destructive
ways for market participants, undermine the
market’s credibility, and discourage long-term value
creation and investment.
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 Short-Termism
 the effects of short-termism on capital investment, such
as investment in fixed assets and new equipment, are
generally not as adverse as on revenue investment
because the risks are relatively lower, payback period is
shorter and the amount spent is often capitalised and
therefore does not affect the current period's profit.
 the effect of these pressures would be to reduce capital
investment, in particular revenue investments in research
and development, training or education with their
attendant uncertainty and long-term nature, and to
increase the bias towards projects with
short-term payback periods
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 Short-Termism
 short-termism within management can distort
decision making and add difficulties in
international competition
 the counter-argument is that such pressures, to
the extent that they are felt at all, are useful
because they help to eliminate corporate slack,
to the long-term benefit of the businesses
 supporters of industry (Richard Branson, for
example) argue that the financial markets pay
more attention to the short term and managers
are therefore acting under pressure from the City
of London
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 Short-Termism
 there is some evidence to support such an
argument: the contested takeovers in the UK and
suggestions that the financial markets do not
understand or that they ignore the technological
information given out by companies
 others, who are in favour of the City, claim that
the stock market's short-termism is not proven,
and argue that the real culprits are the managers
who favour short-term decisions quite
independently of any spur from the financial
markets
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 Short-Termism - External
Factors
External factors are found outside
the organisation and include:
 general economic environment
 institutional shareholders and their objectives;
 performance evaluation of fund managers acting on
behalf of the owners
 type of investment and treatment of revenue
investments within generally accepted accounting
practices and standards
 efficiency of financial markets including the
quality of information given by the
management of companies to their owners
 managers' perception of the financial markets
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 Short-Termism - Internal
Factors
Internal factors are generated within
the management itself and include:
 organization structures and

management control styles

 performance evaluation measures

 remuneration of top managers

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 Investor Ratios (1)
 Earnings per share = net profit after tax
number of shares issued

 Dividend per share = total dividend paid

number of shares issued

(both figures quoted in pence per share)

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 Earnings per share ratio (EPS)
 The Earnings per share ratio, often shortened to
EPS, measures the earnings a company makes
for each share in existence. It is calculated by
taking a company’s net earnings and dividing
them by the number of shares in issue.
 A higher EPS is regarded as better than a low
EPS as it means investors are earning bigger
profits for every share they own. Investors look
not only at the current EPS but at estimates of
future EPS to get an idea of the profits they will
earn in future years.

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 Investor Ratios (2)
 Earnings yield = earnings per share x 100
market price per share

It is a simple way of expressing, in %

terms, the investors return on the current
market price per share

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 Dividend per share
 It is the amount of the dividend that shareholders
have received for each share they own.
 dividend per share does not usually need to be
calculated by investors as it is usually disclosed
 companies may pay interim dividends during the
year as well as a final dividend. These should all
be added together to get the total annual amount
in order to calculate the dividend per share

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 Investor Ratios (3)
Price/Earnings Ratio = current market share price
(P/E Ratio) earnings per share

Dividend Cover = earnings per share

dividends per share

Dividend Yield (%) = dividend per share x 100

current market share price

Market Capitalisation = no. of shares issued x current price per share

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 Price Earnings ratio (P/E)
 the ratio you will see mentioned more than any other
is the Price Earnings Ratio, which you will often see
represented as P/E.
 the P/E measures whether a company is cheap or
expensive. It is calculated by dividing a company’s
share price by its earnings per share (profits after tax
divided by the number of shares in issue)
 indicates the number of years it would take, at its
current earning power, to earn an amount equal to its
market value

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 Price Earnings ratio (P/E)
 As a rule, the higher the P/E, the faster its
earnings are growing but if the P/E is high
compared with other companies in the same
sector, it could also mean the shares are
overvalued.
 This ratio enables any business to be compared
with another, although in reality investors tend to
compare companies against those in the same
industry sector or against the P/E on the entire
market.
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 Price Earnings ratio (P/E)
 Investors look not only at P/E’s based on the
past year’s earnings but also at estimates of
future P/E’s, also known as prospective P/E’s.
This gives investors an idea as to how fast a
company’s earnings are expected to grow in
the future and, therefore, whether their
shares are worth buying or not.
 the P/E ratio is a measure of the
market’s confidence in a particular
company or industry
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 Dividend cover ratio
 If you are investing in a company that pays
dividends, you need to understand a company’s
dividend cover. This ratio tells you if a company
will be able to pay its dividend
 It is worked out by looking at the margin by
which the dividends paid to shareholders are
exceeded by the company’s earnings per share
 Companies, and investors, like there to be a
margin of at least 1 so the dividend payout will
not be affected by a short term fall in profits.
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Dividend Cover for major UK
companies (November 2014)

Barclays Bank 1.34

Tesco 1.90
BT 2.56

GlaxoSmithKline 1.35
Next 3.33

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 Dividend yield %
 The requirement of equity investors will differ in so far
as some people may buy shares in order to generate
income, whilst others may buy the shares as a way of
creating a capital gain sometime in the future.
 investors who are looking for income, may select and
compare potential investments on the basis of the
size of the dividend per share and the current market
share price, otherwise known as the dividend yield.
 it relates the cash return from a share to its current
market value

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 Selected Retailers (2 Nov 2014)

Share Dividend P/E Net Debt

Price p Yield Ratio Gearing
Tesco 173 8.5% 16.4 59%
Sainsburys 245 6.8% 6.7 20%
M&S 406 4.1% 12.6 71%
Sports Direct 644 - 22.1 26%
Next 6445 4.4% 14.0 185%

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 Investor ratios and
investment analysts
 investor ratios serve to measure the ability of the
company to provide the investor with an
acceptable rate of return by calculating the level of
earnings in a company, and the way in which
earnings are split into dividends and retained
earnings.
 the investor wants to be able to compare company
performance year by year, and the comparative
performance within the same industry, and these
ratios are useful tools for such comparisons
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 Next Week
 government based financing
 the efficient market hypothesis
 methods of financing equipment

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