Financial Terms explained. We will be looking to continue to grow this into a glossary of terms over time to explain some of the financial terms and ratios used in analysing potential investment opportunities.
P/E Ratio
Price Earnings ratio (P/E) – If you divide the price of a company’s share by its earnings per share then you come up with the Price Earnings ratio for the company. This can relate to how many years it would take for the earnings of the company to equal the share price. For example, if CBA shares were valued at $85 per share and the Earnings Per Share is $5.30 then the P/E ratio would be 16. Which means at this rate it would take 16 years for the earnings from the company to equal the current share price.
Historically the average market P/E ratio is 15-25. For companies with P/E ratios under 17 it is generally considered that the share price may be good value. However, there are other factors to consider before purchasing a share, such as future growth expectations and the industry in which the company operates.
Further, as the known earnings per share is historical, you are making the assumption that the earnings of the company will remain the same in the future. If the earnings per share increases/reduces or the share price changes the P/E ratio will also adjust accordingly.
Dividend Yield.
Current Dividend Yield = Most recent full year dividend divided by the current share price. This calculates the interest that you earn on shares when you purchase them. For example, if you purchased Telstra shares at $6.30 and the full year dividend is $0.295 then the dividend yield is 4.68%. Some investors look at this as a good return when compared to the interest they can receive on term deposits. However, it is important to remember that share prices can go up and down and the dividend paid may change in the future
The All Ordinaries index
The All Ordinaries index is a measure of the movement of the stock market. It considers about 95% of the shares in our market. Larger companies like BHP and the Commonwealth bank have a greater impact on the movement of the All Ordinaries index due to their size and how much they are traded. While not completely accurate, a simplistic way to think about how the All Ordinaries index works is to add up the share prices of most of the companies in our market and you will come to a figure of approx. $5,300. Which is similar to the All Ordinaries index 5,300 points. So when you see on TV at night that the Index has increased by 50 points, this represents that some shares went up in value by more than those that decreased in value on that particular day.
