Returns on equity
The range of measures used to analyse the return to equity investors is much greater than that applied to debentures, perhaps because this class of investment carries a greater risk, and ordinary shareholders are the most significant group of investors.
Headline Earnings Per Share
Traditionally, the most commonly quoted ratio has been earnings per share (EPS), but FRS 3, Reporting Financial Performance sought to remove what was considered ‘over-reliance’ on the single EPS figure as a basis for judgement of company performance. The ASB argued that accounts need to be analysed in more detail, and that a single figure is open to manipulation. The Institute of Investment Management and Research (IIMR) severely criticised FRS 3, arguing that analysts need a simple way of measuring trading performance, and as a result they formulated what is known as the ‘headline earnings’ figure , which has been adopted by the Financial Times as the basis for the calculation of the Price Earnings ratio. The headline figure is roughly equivalent to the ‘old’ earnings per share, and is calculated as :
‘Headline earnings’ per share
= Profit after tax, minority interests and preference dividends / Number of shares in issue and ranking for dividend
Suppose that Flames PLC has issued 200 million ordinary shares and reports after tax profits of £14 million. There are no minority interests but a preference dividend of £2 million is payable. The headline earnings figure is thus:
= £12 million / 200 million
= £0.06 or 6 pence per share
Note that on its own the earnings per share figure is of limited use, because share prices can vary widely. If Company A has 10 pence earnings per share and Company B has 20 pence earnings per share this does not ...