olegas Jun 19, 2022 / 113 Views
A convenient way to compare several securities with each other is to compare them by the level of current yield (TD). Below we will look at formulas for determining the current yield of bonds and stocks. Please note that it is only correct to compare papers of the same type by TD level. That is, we compare stocks with stocks, and bonds with bonds.
In global financial practice, the term current yield is usually expressed by the English phrase Current Yield and denoted by the abbreviation CY.
Why was the standard created?
IFRS 33 (approved by order of the Ministry of Finance of Russia dated December 28, 2015 No. 217n) establishes the basic principles for the formation of earnings per share and, accordingly, the design and presentation of such an indicator. This standard is designed to achieve high comparability of indicators of both individual organizations for the same time period, and the same organization for different time periods.
The rate of earnings per share gives an understanding of how the business development process is going in the organization. This indicator allows the company’s management to analyze business development and take appropriate management measures to increase the profitability of the organization.
PAY ATTENTION! In contrast to the organization's profit for the reporting period, the rate of profit per share more fully and comprehensively reflects the process of return of funds invested in the business. This is achieved due to the fact that the rate of earnings per share also takes into account new injections of funds into the development of the company.
By looking at the rate of earnings per share, the company's management receives more extensive information about its business, since in this case all of the company's shares that are outstanding, both initial and additionally issued, are taken into account. And for investors, in turn, this allows them to determine their income over a period of time, as well as the dynamics of their growth.
For information on the chart of accounts in IFRS, see the article “Chart of accounts under IFRS (nuances).”
Which securities are potentially the most profitable?
The answer to this question is quite simple: the greatest potential for profit comes from securities with an equally high level of risk. The higher the risk that an investor is willing to take, the higher the return that he can ultimately receive. The key word in this case is “may,” since as the degree of risk increases, the likelihood of receiving income gradually decreases.
Risk-return ratio
That is, in other words, by increasing the degree of risk, the investor simultaneously increases his potential profitability and reduces the likelihood of receiving it. Therefore, in investments it is so important to find that golden mean, that level of risk at which you can count on a relatively high profit with a fairly high probability of receiving it.
Securities such as government bonds have the minimum risk, but also the lowest degree of profitability. Typically, the interest rate on them is comparable to the yield on bank deposits and barely exceeds the current inflation rate. Investing in securities of this type is advisable in cases where the main goal is not to increase, but to preserve one’s funds.
One step higher are corporate bonds of the largest companies. They also have a sufficient degree of reliability, but allow you to get a little more profit (unlike securities issued by the state). Even higher in terms of profitability are shares of the same companies, but the risk for them is also slightly higher. A bond by its nature is a debt security, that is, it implies the repayment of the debt and interest on it in any case. But the share is equity paper. It gives its owner a share in the business of the company that issued it, but at the same time he takes on certain risks (in particular, losses as a result of a possible decline in the stock price).
Even more risky, but also potentially more profitable, are shares and bonds issued by less well-known and less large companies. At the same time, the less well-known a company is, the greater the profit it is forced to promise on its bonds (otherwise no one will want to buy them) and the stronger its shares can ultimately “shoot.” After all, you must agree that the car service center around the corner of your house has much higher potential for possible growth than, for example, Gazprom or Sberbank. A car service center can increase thousands of times by developing its business into a network throughout the city, throughout the country, or, in the end, even throughout the world (it is not at all necessary that it will do this, but, nevertheless, the theoretical possibility of this exists). But Gazprom is already a fairly large organization and it is unlikely that it will be able to increase its market capitalization even by 5-10 times.
There are also such securities as futures and options contracts. They are traded using leverage and, accordingly, the amount of potential profit in this case is much higher; it is directly proportional to the amount of leverage provided. Likewise, the risk increases.
Let's say you decide to buy IBM stock futures. The specification of this futures contract implies trading with a leverage ratio of 1 to 10. That is, at a price of one share of $135, with an amount of $1,350, you can purchase not ten, but one hundred such shares. Although, to be more precise, in this case you will not purchase the IBM shares themselves, but a futures contract for their purchase. But this does not change the essence of the matter much, because after the expiration of this contract you will be able to make a profit equivalent to what you would have had if you sold these same shares. True, in this case, the possible loss will be equal to that which would be brought to you by owning 100 shares of IBM in the event of a decrease in their market value.
Who should apply the rules of IFRS 33?
All firms that list their shares in the capital markets must apply the requirements of IAS 33 and, accordingly, calculate the rate of return per share. In addition, other companies that disclose earnings per share are required to comply with of IFRS 33
The requirements of the standard in question are applied both in the individual financial statements of a separate organization and in the consolidated financial statements of a combined group of companies (clause 2 of IFRS 33 ).
PAY ATTENTION! A prerequisite for the application of the rules of the standard by an individual organization or group of firms is that these companies have shares that are traded on domestic and foreign stock exchanges or on over-the-counter markets.
If an individual company or group of enterprises has submitted financial statements to the securities commission or is just preparing to submit these statements (in order for its shares to be issued), such companies are also required to comply with the requirements of the analyzed standard.
What specific terms should you know to use IFRS 33 correctly?
To use IFRS 33 , it is necessary to know and understand some specific terms.
In practice, most problems with understanding arise around the definitions of “potential ordinary shares”, “dilution”, “anti-dilution”.
Thus, firms applying the rules and requirements of the standard under consideration should keep in mind that along with ordinary shares there may also be potential ordinary shares. This term refers to contracts or financial instruments that give the holder the right to later acquire ownership of common tradable shares.
The next problematic issue is related to dilution. As paragraph 5B of the standard explains, dilution is the possible maximum reduction in the profitability of each share as a result of:
- conversion of all convertible securities;
- that additional shares of the company were issued upon the fulfillment of specified conditions.
The opposite phenomenon is called anti-dilution. That is, this is a situation where the profit of each of the shares of the enterprise increases as a result of the same circumstances listed above.
How is basic earnings per share calculated?
Basic profit per 1 share can be determined based on the following formula (clause 9 of the standard):
BP = PE (Ub) / SRk-vo,
Where:
BP - basic profit per 1 share;
PE (Ub) - net profit/loss for a certain time period, which was received by all owners of the company’s ordinary shares;
SRk-vo is the weighted average number of such ordinary shares of the company that were traded on the market during the time period under consideration.
IMPORTANT! In this case, the numerator indicator must include all items of income or expenses recognized by the company for a certain time period in full.
For more information about analyzing the company’s net profit, see the article “Procedure for analyzing the net profit of an enterprise.”
Accordingly, in practice, organizations may have difficulty both in determining profit and in establishing the level of the average number of shares that were outstanding during the reporting period.
What is dividend yield and why know it?
When buying shares, an investor can make a profit in two ways: through the payment of dividends and through an increase in the price of the security. And if the second strongly depends on the market situation, then the first allows you to predict future income.
Dividend yield is a measure that reflects what percentage of the market value of shares the holder will receive in one year.
In fact, the amount of dividends a company pays during the year is compared to the market price of its shares.
What circumstances should be remembered in order to correctly calculate profit (numerator)?
In order not to be mistaken when calculating net profit per 1 share, firstly, you should remember that the amounts of preferred dividends paid for previous reporting periods cannot be taken into account when calculating the amount of profit for holders of ordinary shares.
For more information on how to calculate the value of a company’s shares, see the article “How to independently determine the estimated price of ordinary and preferred shares.”
Secondly, we should not forget that pitfalls may arise in a situation where securities (convertible) were purchased not at their objective value, but at a slightly inflated price. In this case, you need to keep in mind that the difference between the purchase price and the objective value of the shares should be subtracted from the amount of profit, which will be the basis for calculating the basic profitability of 1 share.
The third important point relates to the complex term of dilution. It, as stated, assumes that the profitability of each share will decline as additional shares are issued or potential shares are converted. In any case, the total number of shares will increase.
IMPORTANT! However, in this case, the profitability of the shares also changes, so the numerator of the above formula for dilution must also be adjusted.
For example, if preferred shares were converted, then dividends on them should also be added to the amount of profit on the basis of which the basic yield per 1 share is calculated.
PAY ATTENTION! Companies should not forget that the numerator of the formula described above is profit after paying all taxes.
Expected return on securities
Competent investment in securities involves a probabilistic assessment of risks and opportunities, selection of an acceptable risk value and a comparable potential level of profitability**. We talked to you about investment risks and ways to minimize them here. Now I will tell you how to assess the potential profitability of securities.
You can estimate expected return (ER) using two different methods. The first method is based on probabilities (mathematical expectation), and the second is based on historical data. Let's start with the probabilistic estimation method.
** As we have already talked to you above, the risk and profitability of securities are directly proportional to each other. The higher the risk, the higher the potential return and vice versa. This state of affairs is due to the fact that the market itself establishes this ratio, because no one wants to buy high-risk securities with a low level of profitability.
Profitability assessment based on mathematical expectation
In this case, all possible options for the size of the expected return are taken into account, along with their probability. Moreover, the greatest weight is given to those values whose probability of obtaining is higher.
The calculation is made using the formula:
To make the calculations clearer, let's give a simple example. Let’s say an investor is faced with a choice of two securities with the following distribution of probabilities of profits for them:
- Security A is expected to yield a 10% return with a 50% probability, a 7% return with a 30% probability, or a 4% return with a 20% probability;
- Security B. The probability of a return of 12% is 30%, the probability of a return of 8% is 35%, and the probability of a return of 5% is 35%.
First, we calculate the expected return for security A:
OD = (0.1*0.5) + (0.07*0.3) + (0.04*0.2) = 0.079 = 7.9%
Now let’s calculate the expected return for security B:
OD = (0.12*0.3) + (0.08*0.35) + (0.05*0.35) = 0.081 = 8.1%
Obviously, the actual profitability value will most likely differ slightly from that calculated using the above formula. You can evaluate the spread of actual values relative to calculated values by calculating the dispersion value.
The variance is calculated using the formula:
For our example, we get the dispersion for paper A:
0,5(0,1 — 0,079)2 + 0,3(0,07 — 0,079)2 + 0,2(0,04 — 0,079)2 = 0,000549
And the dispersion for paper B:
0,3(0,12 — 0,081)2 + 0,35(0,08 — 0,081)2 + 0,35(0,05 — 0,081)2 = 0,000793
Dispersion shows the level of risk that will entail investing in a security for which the expected return was calculated based on probabilities (mathematical expectation). The greater the dispersion, the greater the possible deviation of the actual OD value from the calculated one.
In our example, the dispersion for paper B is slightly higher than the same indicator for paper A. However, the difference between them is quite insignificant (not an order of magnitude), so we can assume that the risks of the securities under consideration are approximately equal. Therefore, all other things being equal, investing in security B is preferable.
What should you keep in mind when calculating the weighted average number of shares outstanding?
Contrary to the misconception that the standard is primarily used to determine profit, in fact IAS 33 has a different purpose - to correctly calculate the number of shares outstanding.
Indeed, depending on the accounting methods used by the company and enshrined in its accounting policies, the approaches adopted when creating reserves, etc., the actual amount of profit can vary significantly. Therefore, standardizing the methodology for calculating the denominator of the formula under consideration (namely, the weighted average number of ordinary shares of the company) is the primary task set by the developers of the analyzed standard.
So, what is important to remember when calculating such an indicator?
In practice, there are certain regulations for calculating the value under consideration. The algorithm of actions is as follows:
- the total number of company shares outstanding since the beginning of the analyzed year is calculated;
- the dates are determined when the total number of shares changed in one direction or another (i.e., upward through an issue or downward through the company’s repurchase of its shares from the market);
- for each individual date, the number of shares in circulation is multiplied by the specific duration of the period during which they were traded on the market;
- the resulting products are added up.
PAY ATTENTION! In this case, the specific duration of a specific period is calculated as dividing the duration of the period in days by the total number of days in the analyzed period.
Despite the existence of this algorithm, in practice there are often difficulties in calculating the weighted average number of shares. Most of the difficulties are related to the following issues:
- from what moment the company’s shares are considered issued;
- from what date shares can be excluded from the calculation, since they fall out of circulation.
Clear answers to these questions are reflected in paragraph 21 of the standard, which states that shares should be accounted for as traded on the market from the very moment when the owner of the shares becomes able to receive a certain return on the invested funds. In accordance with the general rule, this opportunity arises for the owner of shares upon registration in a special register. At the same time, clause 21 of the analyzed standard also contains more complete variations of conditions that may affect the occurrence of this possibility. For example, if common stock is sold in cash, the stock should be considered issued only when the shareholder becomes eligible to receive dividends. And so on.
PAY ATTENTION! Under some circumstances, the number of shares of common stock traded in the market may change even if there is no change in the composition of the firm's resources.
In particular, this can happen if the shareholders of the company decided to pay dividends in shares. The opposite situation is also possible—business consolidation. Under such circumstances, the firm does not receive any new resources, but the number of its shares held by shareholders will increase or decrease.
IMPORTANT! If consolidation or splitting occurs, then clause 26 of the standard requires a recalculation of the number of shares initially outstanding.
How to correctly calculate portfolio return
Another calendar year is drawing to a close. The issue of assessing investment success becomes relevant. Calculating the return on a portfolio for a certain period is a simple task, but it has a number of features. Let's look at the main points that a private investor should know.
The income received from investments is usually measured as a percentage, since the absolute amount of profit directly depends on the size of the invested capital. To do this, the profit amount must be divided by the initial investment amount and multiplied by 100%. For example, if you invested 100 rubles. and earned 8 rubles from this investment, then the income will be 8/100*100% = 8%.
Let this 8% be earned by the investor in 10 months. Instead of an investment portfolio, the investor could place funds on deposit at a rate of 8% per annum for 1 year or invest in an alternative project that promised 15% for 18 months. Did the investor manage his money effectively?
In the financial sector, a single standard has been adopted that allows you to compare different investment options. According to this standard, profitability is assessed as a percentage per annum. To bring income for any period to the annual rate, you need to divide it by the investment period in days and multiply by 365 (or 366 if the year is a leap year).
In our example, 8% was earned in 10 months or 304 days. Then the profitability, expressed as a percentage per annum, will be 8%/304 * 365 = 9.6% per annum . The return on the deposit is already measured in percentage per annum and is 8%. The profitability of the alternative project will be equal to 15%/18 * 12 = 10% per annum. We conclude that on an annual basis, the investor’s portfolio is ahead of the deposit in terms of profitability, but lags behind the alternative project.
Note that this method of reducing profitability for an arbitrary period to an annual rate is simplified. To obtain more accurate results, you should use the following formula:
In the example under consideration, the return on the investor’s portfolio, calculated using the formula, will be: (1+8%) ^ (365/304) - 1 = 9,68%.
Average annual return and CAGR
If the investment period is several years, it is important for the investor to understand the average annual return on his investment. An investor can compare which asset options are most effective for his goals - investing in shares or other financial instruments, for example, bonds or deposits.
The easiest way is to calculate the arithmetic mean, that is, add up the returns for all years and divide by the number of years. If the spread of values is small, the result of such a calculation is close to the truth. But this approach is still not entirely correct and can mislead the investor.
By applying the average return to the entire investment period, we should obtain the same amount of capital as when using the original values. Let's check that this is not the case in the case of the arithmetic mean:
The final amount of capital using the average rate will be 1891.9 thousand rubles. against actual 1839.4 thousand rubles. This means that the arithmetic mean is not suitable for estimating the average rate of capital growth.
A correct assessment of the average annual profitability is carried out using the geometric mean formula. In Excel, you can refer to it by the name SRGEOM(), listing the return values for all years in parentheses. In this case, one must be added to each profitability, and one must be subtracted from the final result. Otherwise, the formula will generate an error.
For those who will calculate profitability without using Excel or want to better understand the logic of the geometric mean, here is a mathematical formula, where the letter r denotes the profitability for each year, and the letter n denotes the number of years:
If there is no data on profitability for each year, but the starting and final capital amounts are known, you can use the CAGR (Compound Annual Growth Rate) formula:
Return on a portfolio with a variable investment amount
The CAGR formula can be used in a situation where the investment amount was deposited once at the start, and the investor did not make any further movements on the account. In practice, this is a rare situation. Typically, an investor deposits or withdraws various amounts from an account during the investment process. In this case, a reasonable question arises: how to calculate profitability?
There are different approaches to calculating the amount of profitability in this situation, but the fastest and most accurate is to use a function in Excel called NETINDOH(). In the English version - XIRR().
The function takes two arrays as arguments: an array of cash flow values (deposits/withdrawals of funds) and an array of dates on which these flows were received (with a plus sign) or paid (with a minus sign).
Let's look at an example. Let’s say that on February 1, 2022, an investor invested 1 million rubles, then on June 1 contributed another 600 thousand rubles. and on September 1 of the same year withdrew 400 thousand rubles. As of November 1, the portfolio is worth 1.37 million rubles. Let's calculate the return on the investor's portfolio.
Enter the data into an Excel table. Deposits of funds are marked with a minus sign, withdrawals of funds and the final amount are marked with a plus sign. Next, we use the NETIROW() function as follows:
This function will give the result in percent per annum. To calculate the profitability for the investment period, the resulting number must be divided by 365 days and multiplied by the number of days in the period.
Thus, it turns out 18.7%/365*273 = 14%, which is exactly how much the investor earned in 9 months in relation to the average capital in the time period under consideration.
BCS Broker
Results
Thus, the rules and regulations of the considered IFRS standard contain a completely clear algorithm for calculating the value of earnings per share.
A company must be guided by such regulations if it has placed its shares on the securities market. It is important to remember a number of points regarding both the procedure for calculating net profit (numerator) and the average number of outstanding shares (denominator). In particular, the profit in the numerator is always indicated after all taxes have been paid. And in the denominator, the correctness of the calculations depends on how accurately the day on which the share became tradable and the day on which it ceased to be tradable are determined. You can find more complete information on the topic in ConsultantPlus. Free trial access to the system for 2 days.
Dividend yield: calculation formula
The dividend yield of a stock is calculated as the ratio of dividends paid for the entire year to the value of the security on the market at the moment. This ratio is expressed as a percentage.
This indicator can be found on analytical resources and in stock screeners (services that allow you to filter data according to your request), or you can calculate it yourself. How to calculate stock dividends? Usually this indicator is also freely available; you can find it on company websites in the section for investors.
Let's consider the algorithm for calculating the indicator using the example of the American company Ford. We know the formula for dividend yield of shares; we will take data for it from public sources.
In 2022, the dividend the company paid for the year was $0.15. At the same time, the shares cost $16 per share. Divide 0.15 by 16 and convert to percentage. We get 0.94%.
It is worth noting separately that companies pay dividends in different ways: once a quarter, once every six months or once. For the formula, it is important how to calculate dividends - it should be the sum of all payments during the year, that is, 12 months of passive income.
