When a company comes to report its performance to shareholders, it’s always good to get a feel for how things are going. Investors should have an ability to compare results on a ‘like-for-like’ basis. In other words, how things are now In comparison to last year.
Knowing what these findings actually mean allows shareholders to ask the vital questions that matter to them. Did the Chief Executive’s new strategy make a difference? Are competitive pressures hitting the company? Is a big enough dividend being paid?
To make this happen, accountants and investment professionals have over the years created a mind-boggling range of metrics. These metrics allow the above questions (and more) to be very easily answered.
At Dabbl we don’t do mind-boggling, so here’s a translation of the key terms you need to know.
Turnover : the amount of money a company takes from customers in a given period. This is usually given as a number for the year.
In action : Last year, Company had a turnover of…£.
Profit : the amount of money that is left from the turnover after all expenses have been paid out. This can cover all sorts of things; the cost of materials, salaries, property rental etc. Typically, headline profits are quoted before tax, and so this should usually be taken into account too.
In action : Turnover – Expenses = Profit.
EBITDA : This stands for – Earnings Before Interest, Taxation, Depreciation and Amortisation. That’s a mouthful, but it’s again another way of looking at how profitable a company is on a very raw basis. It basically means : earnings before interest, tax deductions, depreciation and debt repayments come into play.
Assets – these are items a company owns which have value. Typically they fall into two categories – tangible assets like computers or vehicles, and intangible assets including patents, computer software and even the goodwill of customers. Assets can be used as security against loans that the company needs to operate.
Writing down – accounting rules mean that some assets have to be written down over a period of several years because their value will indefinitely fall. Computers are a classic example of this. You buy a laptop for £1000 with an expectation it will last two years. You depreciate the value of that asset by £500 a year.
EPS – earnings per share. So, you take the total earnings for the company and divide this by the earnings per share. It’s a very commonly used metric by US companies.
P/E ratio – this is considered to be the UK equivalent of the above. Take the value (or market capitalisation) of the company and divide it by the earnings reported. At a glance, an investor can see how their company is performing in terms of earnings on a standardised basis.
Dividend Cover – shareholders are (ideally!) compensated with both a ‘capital return’, (the share price increases) and through the payment of dividends, (a sum of money that can either be withdrawn or reinvested).
The prospect of some dividend income can make companies more desirable investments. Dividend cover is calculated by the following; earnings per share (detailed above), divided by the dividend amount. This gives an indication of how sustainable the payment is. Dividend cover greater than 2 is seen as healthy. If the number is less than 1, the company is paying out more than it is earning to shareholders.
GAAP – underwriting all of the terms above, along with others, is the Generally Accepted Accounting Practice. This is the standard framework for reporting accounts, so any suggestion that numbers do not conform to GAAP should indicate you need to proceed with caution when trying to make those like-for-like comparisons.