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Created on 13.08.2018 | Updated on 27.08.2019

Valuing shares – the five key indicators

What should you bear in mind when evaluating shares? Key indicators help you to assess them. The key indicators may seem daunting and difficult to calculate at first glance. However, once you start to look into it, you’ll soon obtain invaluable insights into a company. Key indicators provide a solid basis for comparing shares and deciding on a particular investment. We outline the five key indicators to bear in mind.

The key indicators when evaluating shares

  • The price/earnings ratio (PER)
  • The price to book ratio (PBR)
  • The dividend yield
  • The return on equity
  • Earnings growth

The price/earnings ratio

The PER is probably the most important indicator when assessing shares. It’s a simple calculation: “a share’s price” divided by “a share’s earnings”. An example calculation: the current price of a share is CHF 100. Earnings of CHF 5 per share were achieved in the previous financial year. The analysts’ forecast for the current financial year is usually used for the earnings. The PER in our example is 100 divided by 5 = 20. In other words, the PER indicates how often the earnings are contained in the current share price or after how many years the earnings have “paid for” the share.

The lower the PER, the better a share’s valuation and the greater the chance of high anticipated company earnings in future. The PER can only be used to compare similar business models, such as companies in the same sector. Exactly why a PER is high or low must always be examined in depth. As a yardstick, it is interesting to note that the PER of all securities listed on the SMI in 2017 stood at 24.6 on average.

The price to book ratio

Dividing the share price by the book value per share gives the price to book ratio key indicator. The book value per share equates to the equity per share stated in a company’s balance sheet. It usually lies below the current market value, so, for example, below the current stock exchange price. An example calculation: if a company has a book value of CHF 5 billion and 200 million shares in circulation, the book value amounts to CHF 25 per share. If the company’s share price is CHF 30 per share, the PBR is 1.2.

If a share’s PBR is below one, this effectively means that the company’s value on the stock exchange is less than all machinery, inventories and property combined. It provides a clear indication of a favourable purchase. However, it should be noted that there are lots of different accounting and valuation methods and the PBR reveals little about companies with high levels of intangible assets. Real estate can also be included in the book value in different ways. The PBR therefore depends heavily on the sector and can be easily “manipulated” – this means there is no hard-and-fast rule for calculating the PBR.

The dividend yield

The dividend yield is calculated by dividing the dividend  by the current share price and multiplying by 100. It indicates the return on the equity capital invested per share as a percentage. An example calculation: if a share’s dividend is CHF 10 and the price stands at CHF 200, the dividend yield is 5%. The higher the dividend yield the better. This must also be scrutinized carefully: a high yield can also be the result of a low share price which may be a sign of a lack of interest from investors or that the company’s outpayments are much too high and are not covered by earnings.

The return on equity

The return on equity is the ratio of equity to a company’s earnings, in other words the return on the capital invested. This figure indicates whether a company generates high earnings with little outlay and whether or not it has a high level of earnings power. A high return on equity is better than a low one. An example calculation: the company generates earnings of CHF 250,000. Equity amounts to CHF 4 million. This means the return on equity is 250,000: 4,000,000 x 100 = 6.25%. The various methods of accounting – in other words, the way in which the company calculates equity – also represent potential pitfalls here. The return on equity can be increased by raising debt capital (e.g. loans) optimizing earnings.

Earnings growth

Earnings growth is the percentage increase in earnings per share from the forthcoming financial year to the one after that. This indicator helps to avoid buying shares in a company whose earnings are stagnating or falling. Comparing earnings growth with the above-mentioned PER gives the price/earnings to growth ratio (PEG). For example, if the PER is 20 and the future earnings growth forecast is 20%, this means the PEG is 1. A value of 1 is generally regarded as a fair valuation, whereas shares with a PEG of below 1 are deemed undervalued.

There are always unknown factors

These five indicators are the most important and most frequently used benchmarks for evaluating shares. It is nevertheless important to note that there are always uncertainties and unknown factors. It is not always immediately obvious what a reasonable comparative value is for the indicator. Carry out thorough research, study the annual financial statements and compare companies with each other, within the industry and with benchmarks. The better informed you are about a company and its financial position, the clearer the picture is for evaluating shares. For more information on shares, see the article “The various types of shares”. 

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