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 TROUBLE TO ADAMJEE INSURANCE CO 22 PER CENT INCREASE IN AGRICULTURE CREDIT RATIO ANALYSIS WITH DIVIDEND PER SHARE FIGURE A Ratio analysis with dividend per share figure.

A company distributes its earnings in the form of dividends to its shareholders.

By Altaf Noor Ali, ACA.
Nov 05 - 11, 2001

This article proposes a fresh and integrated approach starting from dividend per share and exames its various components. Specifically, the purpose of this article is to present a framework that links seemingly different ratios used for financial analysis such as earning per share, return on shareholders' equity, book value per share, dividend payout, price/earnings and dividend yield ratio.

In this article we will see that dividend per share is a product of earning per share and dividend payout ratio. The first element eps, in turn, is a product of return on shareholder's equity and book value per share. Similarly, the second element of dividend payout ratio is a product of price/earning and dividend yield ratio.

We will take a practical example as a proof that the focal point of financial analysis should be dividend per share which in its expanded form is a product of return on shareholder's equity, book value per share, price/earning and dividend yield.

The advantage of this approach is that it integrates the ratios mentioned above in a pyramid form that is easier to conceptualise and validate. I expect this approach to the find its way with users of financial information who believe that memorising ratios is the only way to sail through this important piece of analysis.

Example: To demonstrate this approach, I have decided to use figures from the annual report 2000 of Fauji Fertilizer Company Limited. Let us consider the following-

 2000 1999 Dividend (Rs. in '000s) 2,051,968 2,051,968 Profit after tax (Rs. in '000s) 2,643,913 3,087,276 Capital (Rs. in '000s) 8,869,045 8,869,045 Number of shares (in '000s) 256,496 256,496 Price per share (Rs.) 40 50

Analysing Dividend per share: Dividend per share is simply the amount of dividend paid to the shareholders. Dividends are mainly of two types: stock dividend or cash dividend.

In case of stock dividend, 'bonus' (meaning additional) shares are issued to the shareholders in proportion to their holdings. Earnings are 'capitalised', i.e, treated as a 'contribution in kind' from shareholders towards the paid-up capital of the company. As a result, stock dividend increases the paid-up capital of a company.

In a way, stock dividend can be seen as an extension of cash dividend. The only thing is that instead of paying cash to the shareholders, fully paid-up additional shares are issued, which participate in the future dividends.

Example: Company A declares 10% stock dividend for the year ended 30th June 2001. It simply means that the company will issue one additional share for every ten shares held by the shareholder. If a shareholder owns 1000 shares on the date declared for payment of stock dividend, he will receive 100 additional shares as 'bonus' shares.

Cash dividend is that part of earnings of a company which is paid to the shareholders in cash. It is expressed in terms of percentage of the facevalue of each share.

Example: The paid-up capital of Company A is 1 million shares of Rs. 10 each. The company declares a 'cash' dividend of 40% for the year ended 30th June 2001.

Simply, it means that the company will pay Rs. 4 per share to shareholders as cash dividend, although the actual amount shareholders get is Rs. 3.60 per share, after 10% witholding tax deduction.

Let us now apply the following approach to link the ratios mentioned above-

 Dividend per share Earning per share Dividend payout ratio

The above pyramid basically shows that-

Dividend per share= Earning per share multiply by Dividend payout ratio.

The result of our solution are stated below-

 2000 1999 Dividend per share (Rs) 8 8 Earning per share (Rs.) 10.31 12.04 Dividend payout ratio 0.776 0.665

The dividend payout ratio can also be expressed in the form of a percentage as 77.6% (1999: 66.5%).

The composition of the ratios above is as follows-

 Dividend per share= Earning per share multiply by Dividend payout ratio | | | Dividend Profit after tax Dividend Number of shares Number of shares Profit after tax

Note the 'Profit after tax' cancels itself out with each other and gives us dividend per share.

Analysing eps: Earning per share is computed in accordance with International Accounting Standard 33. It is a mandatory disclosure in the financial statements of a listed company. The eps figure is stated at the end of the income statement (or Profit & Loss Account) and its computation is also mentioned in the form of a note to the accounts.

Shareholders' equity comprises the paid-up capital and reserves. The return on shareholders' equity (ROSE) is computed here with reference to shareholders' equity as on balance sheet date. The other methods of computing ROSE are also acceptable but are not valid for this approach.

 Earning per share Book value per share Return on Shareholders' equity

The result of our solution are stated below-

 2000 1999 Dividend payout ratio 0.776 0.665 Price/Earnings per share 3.88 4.155 Dividend yield ratio 0.2 0.16

In addition to dividend payout ratio, dividend yield can also be expressed in terms of a percentage as 20% (1999: 16%).

The composition of the ratios above is as follows-

 Dividend payout ratio= Price/Earnings per share multiply by Dividend yield | | | Dividend Price Dividend Profit after tax Earnings Price

Note that 'Price' cancels itself out in the equation and the net result is dividend payout ratio. By 'price' we mean the closing rate at which the scrip was traded at the stock exchange at a specific date.

Putting it all together:

In a consolidated form, the capsule will look as follows-

 Dividend per share= Eps multiply by Dividend payout ratio Book-value per share multiply by Return on Shareholders' equity. Price/earning ratio multiply by Dividend yield ratio Return on Sales Equity turnover

As can be seen from above, the 'return on shareholders' equity' has been split by 'Dupont Method' which is the starting point of comprehensive analysis of other elements of profit & loss account (or income statement).

In terms of formula, the above can be written as-

 Dividend Profit after tax Dividend Number of Shares Number of shares Profit after tax | | | | Shareholders' equity Profit after tax Price Dividend Number of shares Shareholders' equity Profit after tax Price

The consolidated analysis of our example will therefore be as follows-

 Reference Computation 2000 1999 Dividend per share (Rs) 1=2*5 Dividend/Number of shares 8 8 Earning per share (Rs.) 2=3*4 Profit after tax/Number of shares 10.31 12.033 Book value per share (Rs.) 3 Shareholders' equity/Number of shares 34.58 33.38 Return on shareholders' equity 4 Profit after tax/Shareholders' equity 0.2981 0.3605 Dividend payout ratio 5=6*7 Dividend/Profit after tax 0.776 0.665 Price/Earnings per share 6 Price/Earning per share 3.88 4.155 Dividend yield ratio 7 Dividend/Price 0.2 0.16

Conclusion: The beauty of foregoing approach is the specified sequence it provides to the six most important pieces of corporate financial information and ties them up together to validate dividend per share figure.

Furthermore, this approach alerts the user of any discripencies if the ratios do not tie-up, which may well be for valid reasons. For example, where the paid-up capital of the company increases during the year and new shares not are not entitled for dividend, or in case of where stock dividend is declared in which case the IAS33 prescribes that the eps of the previous period to be revised.

The author dedicates this approach to the memory of his grandfather late Hashim Lal Muhammed who was an accountant himself.