 Hello and welcome to this session in which we would look at market ratios, which is the last tools for our financial statement analysis, which is recording part seven of seven. In the prior session, we looked at all these tools as financial statement analysis. So what are market ratios? Well, they measure the attractiveness of the companies for potential investors. Here as an analyst or as a potential investor, you are looking at these ratios to determine whether you should invest in the company or not. Now, the best way to do this is to actually look at the numbers, look at the figures to see how they are computed and how they are interpreted. And what can we conclude from that information? Once again, we're working with the same set of financial statements, balance sheet and income statement. For the purpose of this example, we're going to assume that we have one million shareholders because that's important. And we're going to assume there are no changes throughout the year. So it's one million shareholders throughout the year. The dividend per share we paid 15 cents per share for the whole year and the dividend payout, the whole dividend payout was 150,000, which is simply put, we paid 15 pennies in total for the million shareholders, which had up to be 150,000. We're going to start to look at earnings per share and earnings per share is computed by taking net income, the profit, then deducting preferred dividend and dividing everything by the weighted average common shares. Now, on the prior session, I failed to mention something when we looked at the profitability ratios and that is when you compute return on equity, return on equity, you will take net income minus any preferred dividend, but we assume for our example, there are no preferred dividend. And the reason we deduct preferred dividend because we have to find out how much the common shareholder are getting because the preferred dividend, they need to be paid first. They have a preference. And that's why we always deduct them when we're looking at those stockholders, equity related, related ratios. So simply put, for our company, earnings per share, which is we earned 398,950 and we have 1 million shares. And here we can maybe go with two decimals. So earnings per share, each shareholder, I'm just going to round it, but you guys get the point. I just want to make sure we don't, so we see where point four is coming from. So approximately each shareholder would receive 40 pennies. This is earnings per share. Now the company, again, don't distribute all the earnings, but that's the computation. Earnings per share is very important. Why it's very important? Because it's going to determine, it's going to help determine the stock price. Because when you buy a company, what you care about is the earnings of the company. And especially you're looking at future earnings, but based on the current earnings, you can predict the future earnings. So if we're looking at the earnings of the company, this is 40 pennies, now we're going to do some what-if scenario. So let's assume, again, I just make up this number, eight dollars. Let's assume the stock price today is eight dollars. Then we can compute something called PE ratio or price earning ratio, which is taking the price per share divided by basic earnings per share. So if I take the price divided by the basic earning, what I find out is the PE ratio is 20. Now we need to interpret, what is this PE ratio? What does that mean? Here's what it means. It means this company is making 40 pennies for every shareholder, for every share, for each share. So each share is making 40 pennies, because if I take all the earnings and I distribute it to the shareholders, each one will get 40 pennies. The investors are willing to pay 20 times this earnings. What do I mean by 20 times? Well, let's see, let me get my calculator here. And if I took 0.4 times 20, I'm going to get eight dollars. So hold on a second, what are you saying? But you already gave me the stock price. True, I did give you the stock price, but what I'm trying to tell you is the investors, the investment community will do what? The investment community will determine this PE ratio. So the investment community will say, we should pay. This is also called the multiple. What is the multiple or the PE ratio? It tells them how much they should pay. What's the multiple per earnings? Now, if the company has a lot of bright future, a lot of prospect, what we do is we take the earnings of that company or the future earning and we multiply it by the multiple. Now, historically, historically, again, this is over a long period of time. If we're looking at the S&P 500, usually companies are priced 15 to 25. Now, this could be sometimes they go higher, sometimes they go lower, but this is what's called normal. What does normal mean? Normal, make sure you have it in quote. Normal means when the company makes a dollar in EPS, we multiply it by, let's assume we're going to give it a 20 multiple. We should pay $20 for this company. It means for every dollar and share, we're paying 20 times that. So the earnings, what I'm trying to say, the earnings drive the stock price. I'm going to make a small experiment to show you how if the company fudged their sales, what would happen to the earnings per share? What would happen to the PE ratio? And what should happen to the stock price? But here we are assuming that this company is fairly priced. And it deserves a 20% multiple. So the community, the investor community believe this company deserve a 20% multiple. Now, how that multiple comes out with? Well, that's what the market basically agreed on in a sense that this is what other companies are being priced at the industry overall. So let's assume for the sake of illustration, the company was able to fudge the numbers and able to add $300,000 in fake income. So if we add $300,000, now the bottom line now it's $635,000. Notice what happened. Earnings per share becomes, earnings per share becomes 64 pennies. Well, what does that mean if the earnings per share becomes 64 pennies? Remember what we said. We said if we all agreed that we should pay 20 times the earnings, 0.64 times 20, this stock price should be priced at 12.8. So notice what's going to happen is 12.8, what's going to happen? The stock price, I'm going to change this because I told you if we say, if this is what we all agree on, so the price should be 12.8. And as a result, the multiple becomes 20. So let me just do two decimal point. So what did I do? What I showed you or what I tried to illustrate, the fact that if you fudge the numbers and accounting, if you reduce your expenses or increase your income, you're going to increase your earnings per share. If the investment community says you deserve a 20 multiple or 40 multiple, some companies, they have high multiple. Let me just show you what few companies will have. For example, Apple computer, let me show you their PE ratios. Their PE ratios is 30. Their earnings, so their EPS is $5.61. So today, the investment community think the 30 is a fair multiple. So if we take 5.61 earnings per share times 30.84, that's going to give us the stock price of Apple, which is 173, which is 172.99. If Apple increased their earnings per share and still everybody thinks the PE ratio is 30, then you will take that additional earnings per share. Let's assume somehow they were able to increase their earnings per share to 8, 8 times 30.84. The stock price should be, it doesn't mean it's going to be 246 if they can increase their earnings per share to 8 dollars, which is that's a huge increase. But the stock price would reflect this if the investment community, Apple is has a 30% multiple. So that's what I'm trying to show you. So what I said, I said, let's assume that this company deserves a 20% multiple for every dollar they make. The investors are willing to pay $20. And this is what I was trying to show you that if you increase the earning, if you increase the revenue, then you would change the perception of the market and the stock price will react. Let's go back to the original data. OK, so this is the PE ratio, and this is a very important figure, very important figure in the real world. Before I proceed any further, I would like to remind you whether you are an accounting student or a CPA candidate to take a look at my website, farhatlectures.com. I don't replace your CPA review course nor your accounting course. I'm a supplement, I'm a useful addition to your resources. I can help you do better. So you are ready to succeed on your CPA exam, focus on your career and do well in life. This is a list of my course catalog, lectures, multiple choice resources that's going to help you succeed. Invest in yourself. My CPA resources are aligned with your Becker, Wiley, Roger and Gleam. So it's very easy to go back and forth between my material and your CPA review course. I also give you access to all the AI CPA released questions. And we're talking about 1500. Those are actual CPA questions that appeared on the previous exam in addition to thousands of additional CPA questions. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording. Share it with other connect with me on Instagram, Facebook, Twitter and Reddit. So let's discuss the dividend payout. The dividend payout measures how much the company is distributing in dividend to the investors. So what we do is we take the cash dividend, how much they pay cash dividend relative to their net income. And I said, let's assume they paid 150,000. We'll take this number, divide in it by net income. And it seems they distribute 37.6. Now the retention ratio is the difference. So if you take one, if you take one minus this ratio will tell you how much they keep in retained earnings. Because what they don't distribute, they keep. So one minus 0.376, they keep 62.4% of their earning for future investment. Now, if you are looking for dividend, you want to invest in a company with a high dividend payout. For example, certain companies, like for example, that's called real estate investment trust or called REIT, they have to pay 90% of their earnings in dividend. Otherwise they would lose a certain tax status. So if you are looking for income, if you're a retiree, you would invest in companies that would have a high dividend payout. Now, not all companies pay dividends. Certain companies, they don't pay dividend. Why not? Because they want to keep that high retention to reinvest in the company. And sometimes it's in the best interest of the investors because the company will have many projects to do. Now let's take a look at Apple. Apple has a, they don't tell us the dividend rate, but we could have a dividend yield. How much they pay per, how much they pay as a dividend yield? I believe they do. Let's look at their statistics. Let's see if they have a payout ratio. So this is their profit margin return on asset. Let's see if they have a payout, payout ratio. So notice Apple, they pay 15%, this is their payout ratio. 15% of their earnings is paid out, which is, it's, you don't think that's a lot, but they pay billions and billions of dollars in dividends or they're very generous. But the point is you want to look for those companies that have high dividend payout ratios. Dividend yield is another measurement, but this tells you how much you are earning for one share in dividend. So you're going to look at you, if you buy the stock today and you paid $8 and the company is paying 15 pennies per year in dividend, while you'll take 15 pennies divided by eight, you are earning 1.88%. Again, the higher this number, the better off you are. How do you improve this number? Well, hopefully if the company makes more profit, they will increase their dividend yield or you want to wait until the stock drops. You buy it, if you buy it at, let's assume rather than eight, you buy it and it drops to 6.5, then you buy the stock, your dividend yield will increase to 2.31. So this is how you can improve your yield, wait until the stock price drops or the company will make more, will company make more and they will distribute more. So this is the dividend yield. At the end of this recording, I'm going to remind you to visit farhatlectures.com, work multiple choice questions to learn more and be confident in this topic. If you're studying for your CPA exam, don't short change yourself, subscribe, invest in yourself, good luck and stay safe.