The ongoing uncertainty around the coronavirus means the stock market has plunged. What the government, and central banks around the world, are doing so far is clearly not reassuring investors. And interest rates have been cut even further. This makes saving into a bank account even less appealing than it was before. In his budget, Chancellor Rishi Sunak revealed £30bn of measures to support the economy. Yet the FTSE 100 fell last Wednesday, the day of the budget.
In this falling market, I’d be tempted to do more research into companies that could offer a valuable combination of income and growth potential. There are many ways to find companies like this. Indeed, many Foolish writers identify them daily. These five ratios serve as a starting point for identifying potentially great companies. That means companies that could bounce back strongly when the stock market recovers.
The value ratios
The P/E ratio and PEG ratio aren’t particularly complicated to work out. They certainly don’t require a maths degree, or even an A-Level. For anyone serious about investing in individual shares, they’re a baseline required to assess whether a share is cheap or expensive.
The Price-to-Earnings (P/E) ratio measures the relationship between a company’s stock price and its earnings per share. The ratio is calculated by dividing a company’s current stock price by its earnings per share (EPS).
The Price/Earnings-to-Growth (PEG) ratio is a good one to use in conjunction. It is used to determine a stock’s value. But it also factors-in the company’s expected earnings growth. As such, it provides more detail on value than the P/E alone. It’s calculated by dividing the P/E by earnings per share growth.
The dividend ratios
The dividend yield is our third ratio and is a useful figure for working out income from shares. Up to a point, the higher the better. But dividend yields that are too high can be a sign that a cut is coming. This usually also results in a steep share price fall. Most financial websites show the dividend yield of listed companies.
To better understand what might happen in future with the dividend, and if it’s sustainable, an investor would be well advised to also look at ratios four and five. These are dividend cover and dividend growth.
The former shows how well earnings cover the dividend payout. A figure above two times is great. But some larger FTSE 100 companies can operate between 1.1 and 1.5 for many consecutive years without the need for a dividend cut. This is riskier though, especially if the economy worsens.
The rate of dividend growth is also important. That’s because year-on-year increases in the dividend over time add up to larger shareholder payouts. This plays a big part in helping investors make money from shares. They can reinvest income back into buying more shares. And they get the income from those additional shares. This is a phenomenon called compounding.
I hope these simple five figures will help you find shares with growth and income potential.
Andy Ross owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.