When we buy shares it's like anything else, we are trying to buy them at a bargain price. We do so with the expectation that over time the value of the company (and thus the value of each share) will increase, meaning our small piece of the company is now worth more.
Many companies share their annual profits amongst their shareholders by paying them dividends. So each year, if the company we have shares in makes a profit, we get paid a portion of that profit.

As a shareholder we are interested in calculating the amount of profit and how this profit compared to the amount invested in the company.

Calculating the price-to-earnings ratio allows investors to compare different companies or different dividends. The lower the price-to-earnings ratio the better the result for an investor as it shows that they have invested less for each dollar of profit.

Price-to-earnings ratio: \text{P/E ratio}=\dfrac{\text{current share price}}{\text{dividend per share}}

Examples

Example 1

The annual earnings per share is \$1.25 and the market price of the share is \$12.25. Calculate the price-to-earnings ratio.

Worked Solution

Create a strategy

Use the formula: \text{price-to-earnings ratio}=\dfrac{\text{price per share}}{\text{earnings per share}}

Apply the idea

\displaystyle \text{Price-to-earnings ratio}	\displaystyle =	\displaystyle \frac{12.25}{1.25}	Substitute the price and earnings
	\displaystyle =	\displaystyle 9.8	Evaluate

Idea summary

Price-to-earnings ratio: \text{P/E ratio}=\dfrac{\text{current share price}}{\text{dividend per share}}

Dividends

Companies share their profits with their shareholders by paying out dividends either as

a dollar value per share or
a percentage of current price of the share which is known as a dividend yield.

Dividends and yields:

\displaystyle \text{Dividend per share}	\displaystyle =	\displaystyle \dfrac{\text{company profit}}{\text{total\ number\ of\ shares}}
\displaystyle \text{Dividend yield}	\displaystyle =	\displaystyle \dfrac{\text{dividend per share}}{\text{current share price}}\times \dfrac{100}{1}\%

Examples

Example 2

Calculate the dividend per share when a company's net profit of \$373\,520 is to be distributed evenly among its 128\,800 shares.

Worked Solution

Create a strategy

Use the formula: \text{Dividend per share}=\dfrac{\text{company profit}}{\text{total\ number\ of\ shares}}

Apply the idea

\displaystyle \text{Dividend per share}	\displaystyle =	\displaystyle \dfrac{373\,520}{128\,800}	Divide company profit by the number of shares
	\displaystyle =	\displaystyle \$2.90	Evaluate

Example 3

Calculate the dividend yield when a firm with a share price of \$38.20 pays a dividend of \$1.38 per share. Round your answer to one decimal place.

Worked Solution

Create a strategy

Use the formula: \text{Dividend yield}=\dfrac{\text{dividend per share}}{\text{current share price}}

Apply the idea

\displaystyle \text{Dividend yield}	\displaystyle =	\displaystyle \dfrac{1.38}{38.20}	Substitute the price and dividend per share
	\displaystyle =	\displaystyle 0.036	Evaluate
	\displaystyle =	\displaystyle 3.6\%	Convert the decimal to a percentage

Idea summary

Dividends and yields:

\displaystyle \text{Dividend per share}	\displaystyle =	\displaystyle \dfrac{\text{company profit}}{\text{total\ number\ of\ shares}}
\displaystyle \text{Dividend yield}	\displaystyle =	\displaystyle \dfrac{\text{dividend per share}}{\text{current share price}}\times \dfrac{100}{1}\%

Outcomes

U1.AoS2.6

concepts of ratio, proportion, percentage, percentage change and rate, and unitary method

4.05 Shares, dividends and yields

Ideas

Shares, dividends and yields

Examples

Example 1

Dividends

Examples

Example 2

Example 3

Outcomes

U1.AoS2.6

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