Forget DUDE - good financial investors should really be thinking about ROE and EPS
PUBLISHED: 11:49 05 August 2019 | UPDATED: 11:49 05 August 2019
It's not just Downing Street's newest resident, PM Boris Johnson, who is using them - acronyms and abbreviations can assist savers and investors too, says Peter Sharkey.
You would like to think that as the odds-on favourite to become the new prime minister as soon as Theresa May announced she was quitting Downing Street and the leadership contest to replace her began in earnest last month, Boris Johnson and his closest allies have been busy working on their plans for a new government.
Let's hope so. Following an initial and mercifully short period of congratulation, Mr Johnson's in-tray looks pretty full, especially after his inaugural speech as PM on the steps of Number 10, he added a number of additional commitments to the major one he has pledged to deliver.
Perhaps Mr Johnson's pre-coronation planning centred solely on when to call a general election (bookies offer 5/4 against it being before the end of the year and 7/2 against it happening in 2020), because there's a prevailing sense that his use and promised application of the mildly amusing 'DUDE' acronym is a tad too optimistic.
Indeed, before he settles into life as prime minister, I have a DUDE acronym of which he may wish to take notice.
He should Dash to the barbers and get a haircut befitting a 55-year-old man. He should also Understand that he's the prime minister and should look the part. Wear a belt, man. It wouldn't be a bad idea were he to Dispense with the demonstrative, Benny Hill-style behaviour; the dishevelled salute on the steps of Downing Street was embarrassing. Finally, he should Experience the joy of a new pair of shoes. Preferably ones that have recently been introduced to shoe polish.
Of course, everyone will be offering Mr Johnson their own twopenneth worth of advice for the foreseeable future, which means it's extremely unlikely he'll be afforded much time to reflect on his longer-term strategies. Few will envy his position.
While well-timed acronyms can, in Mr Johnson's case, raise a laugh and generate snappy headlines, for investors, they're usually considered similar in usefulness to abbreviations; both are often the bane of investors' life.
Yet there's no reason for this. Moreover, you do not need to know them all. What else is Wikipedia for?
However, there are a handful with which investors probably should be familiar, though it's more important for them to understand the definition rather than know the order in which the letters are arranged. Here's three worth remembering.
One of the most important is ROE. Food buffs will know the traditional definition for roe that comes solely from fish of the Acipenseridae family, also known as sturgeon, is caviar (it's a different interpretation in the US), but investors define ROE as return on equity.
ROE is often used to compare a company's profitability with that of another - usually in the same sector - to ensure you're comparing like-with-like.
It's calculated by dividing a company's annual income by shareholder equity. Shareholder equity is defined as a company's assets minus its liabilities and is also known as book value. The major drawback of ROE is that it offers a company snapshot rather than acting as a predictor of future performance.
Then there's EPS. Older readers will recall buying the vinyl version - extended players (EPs)usually had an extra couple of tracks on them - but in an investment environment, EPS stands for earnings per share. Like ROE, it's a useful comparison tool for measuring profitability. It's calculated by dividing a company's net income by the number of shares it has issued; the result shows how much the company is making on a per-share basis.
A third investment abbreviation, PE, has nothing at all to do with your school gym classes and everything to do with gauging a company's commercial fitness.
The price / earnings ratio is a measure that fluctuates because the numerator (the top number in a fraction) is a company's share price. The denominator, ie the bottom value, is its EPS.
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If, therefore, a share is selling for £5 and it earned £1 per share (EPS), the PE is five, but what does this mean?
Ordinarily, companies with low earnings have relatively high PE ratios because investors believe they will grow and become more profitable in future. By contrast, well-established, profitable outfits might have much lower PE ratios because earnings are expected to remain stable. In recent years, however, ratios at these reliable companies have grown as investors have preferred to buy quality which comes with a profitable track record.
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THE WEEK IN NUMBERS
A Boris Johnson special...
On Wednesday, Boris Johnson became the 20th British Prime Minister to have attended Eton College (the first was Sir Robert Walpole). Mr Johnson is also the 28th PM to have graduated from Oxford University; the first was Lord Wilmington.
Mr Johnson is the third Prime Minister to be divorced. The other two were the Duke of Grafton (in 1769) and Sir Anthony Eden, who divorced his first wife in 1950. BoJo divorced first in 1993 and has another divorce, from his second wife, pending.
One of the shortest Prime Ministers (he's 5'9"), BoJo is the first to have been born in the USA. Only three other Prime Ministers have been born outside of the UK: Lord Shelburne and the Duke of Wellington (both born in Dublin), while Bonar Law was born in Canada.
For more financial advice, check out Peter Sharkey's regular column, The Week In Numbers.