When to buy shares - 6 key figures

Financial ratios can be incredibly useful for deciding whether and when to buy shares. You can view them on our company overview pages or in annual reports; but what do they mean?

1. Dividend yield

Dividend yield reflects how much income investors receive for each pound invested, but it should not be considered in isolation.

A low dividend yield could indicate a high share price, due to positive growth prospects, or it could mean the company can’t afford to pay a decent dividend. Conversely, a high dividend yield may lessen the impact of any fall in share price, but it could raise concerns over prospects and affordability of the dividend in future.

Dividend yield = Net dividend income per share / Market share price

2. Dividend cover

Dividend cover reflects the number of times a company’s profit covers the ordinary dividend. Generally, a ratio of 2 or higher is considered safe, with anything below 1.5 being risky.

At 1, a company’s profits are only just covering dividends. Under 1 means dividends are being paid from retained earnings, which is not normally sustainable.

Dividend cover = Net earnings per share / Net dividend per share

3. Price/earnings (P/E) ratio

The P/E ratio reflects the price investors are prepared to pay for each pound of company earnings. A high ratio indicates that the market expects future earnings to grow quicker than at a company with a low P/E. It should be used to compare with historical performance or companies in the same industry.

P/E ratio = Market share price / Earnings per share

4. Price/earnings to growth (PEG) ratio

The price/earnings to growth ratio (PEG ratio) is seen as a better investment tool than the P/E ratio because it considers future growth, in addition to historical performance.

Shares with a PEG of 1 or lower are considered good value (the lower the PEG, the less you pay for estimated future earnings). However, it is only as reliable as the estimated growth forecast.

PEG ratio = P/E ratio / Estimated future growth

5. Gearing ratio

Gearing reflects to what extent a company is encumbered with debt. Anything over 100 is considered risky, but it varies between industries. 

Gearing ratio = A company’s debt / Market Capitalisation

6. Price-to-book (PB) ratio

The price-to-book ratio can be a useful tool for finding undervalued companies. Anything under 2 is considered good value, while over 2 implies it may be overpriced. It relies on the valuation of assets being accurate and current.

P/B ratio = Market share price / Net asset book value per share

Read more about how to value and assess prospects of an investment