What factors increase earnings per share?
Analysis of company fundamentals
Assessment of the growth potential of a company
Share prices usually reflect the sum of all investors' expectations of the value of a company at that point in time. A stock price represents the balance between hoping and expecting gain for some and fear of losing others. In general, investors are willing to pay more for stocks that are expected to have stable and / or increasing income streams, as opposed to stocks whose income may be more volatile or where the company's future performance is uncertain.
One of the key factors in investor success is understanding exactly what factors affect market expectations and how they can change over time. The mood towards companies is influenced both positively and negatively by many factors.
The main driver of a company's valuation is its ability to grow its profits and ultimately its dividends. There are several ways a company can make more profits over time:
Companies can increase their sales by entering new markets, entering into partnerships and joint ventures, acquiring new contracts or customers, developing and launching new or improved products, improving their marketing and sales offerings, and much more.
When the economy is booming, some companies have the pricing power they need to raise the prices of their current products as demand increases. This is particularly important for raw material producers when the markets for their raw materials go through a bull market.
A company can also increase profitability by reducing costs, even if doing so risks indiscriminate savings. In order to get an impression of the cost efficiency of a company, investors often analyze the percentage relationship between administration, sales, marketing, interest and depreciation costs of a company and its sales. But a look at the operating profit, measured as a percentage of sales (margin), can provide information about the profitability of a company.
Risk of disappointment
Investors must acknowledge that while companies can achieve great success, there are also numerous risks that can cause a company to suffer losses or a dramatic collapse in business. Concerns about negative results can limit the upside of stocks or even cause them to fall.
In day-to-day business, a company can be confronted with all kinds of problems, for example with defective machines, new competitors entering the market, price wars, rising production costs, a negative economic environment, loss of orders or customers and much more.
Political risks vary from country to country, but relate to the possibility of a change of government that could result in negative economic policies in the form of tax hikes, new regulations, nationalizations and other initiatives.
Exchange rate risks
Companies operating in several countries are exposed to the risk that rising and falling exchange rates could affect their sales or cost structure and could increase or decrease the profitability of their foreign business activities, calculated in their home currency.
This risk relates to the possibility that a company could be sued. Legal risks play a role especially in sectors in which patent and intellectual property disputes can arise, which can significantly affect the course of business due to claims for damages and injunctive relief.
In difficult times, companies with high levels of debt can struggle to meet their obligations. They may not have enough financial resources to cover their day-to-day liabilities. Investors can use a variety of metrics to assess a company's financial strength. This includes:
- Debt ratio = total debt capital / total equity (this measures the company's debt financing ratio.)
- Interest coverage = operating profit / interest expenses (This determines the extent to which a company is able to at least service the interest of its debts.)
- Liquidity ratio = current assets / short-term liabilities (This determines the ability of a company to meet its short-term obligations from current funds.)
Assessment of the growth in the market (P / E and PEG)
Another useful question investors should ask is how much the market values a company's stocks compared to its competitors. The reason for this is that higher-valued stocks tend to be associated with higher expectations and thus a higher risk of disappointment, while companies with low valuations and expectations have the potential for positive surprises.
The most common rating indicator is the course Earnings ratio (P / E)which is calculated as follows:
P / E = market capitalization / net profit
P / E = share price / earnings per share
It tells investors what additional premiums are likely to come into play to justify a company's current earnings.
The P / E ratio is how many years it would take the company to generate profit from the current value of its shares. It gives, so to speak, information about the repayment period. A higher P / E ratio therefore indicates higher expectations for earnings growth.
Another key figure for investors, in which the valuation is linked to growth, is the ratio between P / E to earnings growth. PEG = price / earnings-to-growth ratio). It is calculated as follows:
PEG ratio = current P / E ratio / current earnings growth rate
A company with a growth rate of 30% and a PER of 30 would have a PEG of 1, which is a benchmark. A PEG above 1 means that the market is pricing in even stronger growth for the company, increasing the risk of disappointment, while a PEG of less than 1 indicates that there may be upside potential.
The only problem with using the P / E ratio for valuation comparisons is the propensity for markets to mark up prices in certain industries, so comparing against the competition is easier than comparing across a wider range of stocks.
Dividends can also have a significant impact on market sentiment. While profits can be affected by accounting techniques, dividends represent actual cash distributions to shareholders. Dividends have become an integral part of investors' income and return expectations.
Because some shareholders rely on dividends for their returns, companies that lower their dividends are often severely penalized by the market. Companies that completely forego dividend payments usually lose their institutional shareholders, as they are only allowed to invest in stocks that pay dividends. Because of this, companies are only increasing their dividends to levels they can confidently maintain over the longer term.
It should therefore be understood that changes in dividends can provide a good indication of what senior management expects about the company's future results. A dividend increase reflects confidence, while a dividend decrease suggests that the company is facing serious trouble.
- The dividend yield is determined as follows: Dividend per share / price per share
- The higher the return, the higher the current return on your capital from dividends.
Sometimes a high dividend yield indicates undervaluation. At times, however, it can also raise concerns that the dividend may be lowered.
In order to evaluate the risk of the dividend in the current amount, investors can use the Use dividend coverage:
Dividend coverage = earnings per share / dividend per share
This measures the company's ability to cover its current dividend level through its earnings. The higher the dividend coverage, the greater the likelihood that dividends will stay at their current levels or rise, while a level below 1 suggests that dividends could be cut.
There is one more thing to note for equity investors with regard to dividends: when a dividend is declared, there is a cut-off date by which you must have held the shares in your custody account in order to be entitled to the dividend. On the first trading day on which a buyer would no longer receive that dividend, also known as the ex-dividend date, the price of the stock is typically reduced by the dividend amount at the start of trading.
Read more about how to find "Best Dividend Stocks".
Attachments around result reports
Company earnings reports usually attract a lot of attention and activity in the market for two reasons. First, while some developments may come as a surprise, earnings reports and associated conference calls are usually announced well in advance so that investors and the media can keep a close eye on them. Second, analysts publish their earnings expectations in advance, so the consensus on expectations is usually priced into the stock price in advance.
For this reason, investments in the earnings reporting environment are influenced less by actual earnings and more by how reported earnings relate to market expectations. Management's estimates of future quarters, also known as projections, can have an equally large impact on investor sentiment.
Price rallies in the run-up to a results report can also be important. They can indicate rising expectations and a higher risk of disappointment, while price losses in the run-up to earnings releases indicate a lack of confidence and potentially lead to positive surprises.
With so many investors and the media focused on earnings and forecasting, volatility can increase significantly after earnings data is released. Because of this, many companies, especially in the US, post their results after the close of trading. These messages can also influence trends and create significant investment opportunities or turning points for investors.
Systems related to takeover offers
Takeover bids can create a lot of excitement and volatility in the market, which in turn can create investment opportunities. Various factors can affect how a stock reacts to a takeover bid.
The takeover target
Since buyers usually pay a premium when buying a company, the share price of the takeover target usually rises after an offer is made known. Sometimes takeover rumors rally, but such rumors should be treated with caution as they can prove to be false.
How much the price of the takeover target rises depends on the type of offer and whether there might be other bidders. In the case of a friendly takeover, the takeover target is usually traded just below the bid price. In a hostile or contested takeover (i.e. multiple bidders), the price of the takeover target usually rises above the takeover price due to speculation that a higher bid might be made.
Typically, after the announcement of a takeover offer, the buyer's shares tend to lose money, which includes the following risks for the buyer:
- Risk of an inflated price - the possibility that the price paid for the acquisition is too high or that the company will get caught up in a takeover battle that could result in underperformance for the buyer's stock for years to come.
- Transaction risk - the risk that the transaction could fail. This also harbors the risk that the management will be distracted from day-to-day business due to the transaction and the company's performance will suffer as a result.
- Integration risk - the risk that different corporate cultures cannot easily be merged or that forecast synergies cannot be achieved.
If a transaction fails, these effects can be reversed. Finally, a takeover bid can result in other companies in the same industry rallying in prices due to increasing speculation about the possibility of further transactions in this area.
Customer sentiment on our platform
Using the Customer Sentiment feature on our trading platform, you can see how many customers are long on a particular stock compared to those who are short, as well as the monetary value of those positions, shown as a percentage.
Abitrage trading with stocks
Many arbitrage trading opportunities open up with stocks, e.g. with statistical arbitrage in correlating stocks or with risk or merger arbitrage in company takeovers. Learn more about arbitrage trading ..
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