What are Earnings Per Share, PE Ratio, Face Value and Book Value?

While investing it is best to convert everything into ‘per share’.

Why?

Because we, retail investors, are not buying whole companies but only small portions of companies through their shares. Many times retail investors only buy a few shares of a company. Sometimes even only one. So understanding various company aspects at the per-share level makes a lot of sense.

Therefore many important aspects like earnings, book value, cash flow are reduced to the single share level. As a result we have:

1. Earnings Per Share (EPS): Net Profit of the company reduced to a single share.
2. Book Value Per Share: Total Book Value of the company reduced to the individual share.
3. Face Value of a Share: The equity capital of a company is divided into a certain number of units or shares of a certain small value to make it easy to sell and raise the capital. This basic unit value - without ant premium or discount - is called the face value. For example the equity capital of a small private company of Rs.100000 is divided into 10000 shares of Rs.10 each. This Rs.10 per share is called the face value.

Once we have these per-share information in hand, we can make even more important price-value comparisons, like:

1. Price to Earnings (PE) Patio: Measures how many times the earnings we are paying as premium or looking from a different angle, in how many years the investment is earned back.
2. Price to Book Value (P2BV) Ratio: Indicates how many times the book value we are paying as price or at what discount to the book value is the share available currently in the market.

Why these ratios are important?

Value Investing prescribes certain wise thumb rules for making stock buying like:

1. PE Ratio shall not be more than 15. Lower the positive PE number so much better it is.
2. The P2BV ratio shall not be more than 1.5. Lower the positive number it is, so much better.
3. The product or combination of these two ratios shall not be more than 22.5.

You can learn more details in the following related articles:

• Earnings Per Share (EPS) - Definition
• Definition of Price to Earnings (PE) Ratio
• Definition of Book Value per Share

In conclusion,  Earnings Per Share, PE Ratio, Face Value and Book Value are very important concepts related to investing and an investor should know them intimately.

Debt Funded Dividends?

A recent research report by India Ratings and Research, a Fitch group of companies has shown that though the quantum of debt funded dividends have come down still many of the corporates are paying dividends out of borrowed funds.

The study is based on the study of the top 500 corporate borrowers. Of these 500 corporates 65 companies account for 85-88% of the total dividends paid since FY 2010, and hence these 65 companies have been studied.

The 65 companies are classified into three categories:

1. Category A: Free Cash Flows (FCF) are positive and greater than the dividends paid (FCF +ve & > Dividend)
2. Category B: Free Cash Flows (FCF) are positive but less than the dividends paid (FCF +ve but < Dividend)
3. Category C: Free Cash Flows (FCF) are negative and the entire dividends paid id funded by debt (FCF -ve & entirely funded by debt)

The summary of the research report reveals:

Debt Funding of Dividends (DFDs) Shows Downward Trend:

From a level of 22% of the total dividend in the financial years 2010-16, DFDs will decline to an estimated 13%. 

In absolute terms too the DFDs are estimated to come down from an absolute figure of Indian Rupees 90 billion to 58 billion.

Capital Intensive Sectors to be the Main Culprits:

Capital intensive sectors like infrastructure, telecom and power are the main contributors. The reason being the profits are fully absorbed for creation of capital assets and therefore are forced to borrow to pay dividends.

DFDs of capital intensive sectors which contributed 42% of the total in FY 2010-16 are likely to steeply climb to 77% in FY2017-18.

Healthy Corporates to Pay Higher Dividend

Ind-Ra expects the Category A companies to pay higher dividends than focus on growth (at the cost of dividends).

The CAGR in dividends grew at 21% compared to the CAGR growth of 6% in free cash flows.

Unwarranted Dividends by Riskier, Category C Companies

The riskier, Category C companies, wherein dividends are 100% financed by debt, the dividend payout grew at a 11% CAGR between FY 2016 and FY 2010.

Ind-Ra predicts that the possible reason for growth in debt funded dividends is to defend the market capitalisation. It is observed that the market capitalisation of the Category C companies increased 2% despite their free cash flows being negative since the financial year 2012.

In conclusion, debt funded dividends is a horrendous practice and value investors should shun investing in such companies.