Five metrics investors should be paying attention to

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I’ve been investing for a while but mainly in index funds. I’m trying to become a more involved investor, but people are constantly referring to different figures and metrics. Which of these really matter?
Anne

Paul Angell, AJ Bell Head of Investment Research, says:

Different investors are drawn to different metrics and there’s no golden ticket that will guarantee investment success. This doesn’t stop people from trying, and there are various formulas used to predict the success of a company, fund or bond.

You don’t need to understand all of them, or even most of them, to be a successful investor. But there are a few that can help you cut through some of the confusion and find the investments that match your needs. These metrics include total return, relative return, yield, PE (price to earnings) ratio, and sales growth.

This isn’t an all-inclusive list, but it’s a helpful starting point. In this article, we are going to focus mostly on how these metrics can be used when looking at funds, but they can also be applied to individual stocks and, in some cases, bonds as well.

1. Total return

Total return tells you how much the investment has grown over time, factoring in fees, dividend yields and price changes. You can find total return data on each fund’s information page on the AJ Bell website. For example, you can see Fundsmith Equity’s total return in the right-hand column.

Most of us should be happy investors if our money is growing at a good rate over time, and this is what total return can tell us. It’s important to remember that past performance isn’t a guarantee of future returns, so just because a fund has had a strong five-year run, the sixth could be different.

If you are looking to invest in assets to beat an index, total return won’t tell you the full story, as it’s specific to an individual investment rather than what’s happening across the market. To make this comparison, you’ll need to look at relative return.

2. Relative return

Relative return shows how a specific fund performed in comparison to a benchmark. This could be the average of other funds in the sector, an index that is in the same sector the fund invests in, or something else. It’s meant to give you a feel for how an investment performs relative to peers.

You can calculate relative return by simply subtracting the return of the benchmark from the return of the specific fund. If the number is positive, this means the fund is outperforming its opportunity set, and if it’s negative, it’s underperforming.

Funds that consistently outperform can be a sign of a strong management team, which could mean you earn more money than you would investing through a tracker fund. However, this is never guaranteed and often managers will go through periods of highs and lows.

3. Dividend and bond yields

When someone talks about yield, they are typically referring to the income you get from an investment. However, yield can also refer to other metrics such as free cash flow or earnings. You can find yields on that same fund or stock screener page used to see total return.

If you invest in an income fund, the income you receive is generated by the investments inside a portfolio, and that money is passed on to you.

For bond funds, yield is determined by the overall level of coupons earned, and then paid out, by the fund, along with the overall cost of the bonds / fund. So, if a bond costs £100 and has a coupon of 5%, it will have a 5% yield and pay you £5 per year (usually split into two payments). While the yield can change depending on the price of the bond, what won’t change is how much you receive from it. This is because the bond issuer will have already agreed on the coupon they are paying on that bond over time. If they don’t make that payment, they are defaulting and this results in serious trouble for the issuer.

What this means for the investor is that the payments they receive from bonds are typically quite steady.

For stocks, you’ll be looking at dividend yield. Dividends are payments you receive from the company whose stock you hold (or hold indirectly through a fund). Note that not every company pays a dividend. Dividend payments can fluctuate so there is less certainty about the amount you will receive compared to income from bonds.

Dividend yield is calculated by the amount paid out per price of a share. So, if a share was valued at £20, and paid out £1 per share in dividends in a year, it would have a dividend yield of 5%.

If you invest in a distributing version of an income fund, the fund will pay these dividends out to you, however, if you hold the accumulation version of the fund, the dividends will be reinvested automatically.

Occasionally, you may come across an investment with a very high yield, and you’ll want to ensure this isn’t a ‘yield trap’. A ‘yield trap’ is an investment offering a high yield to investors because it’s otherwise very unattractive and is likely to fail. For example, emerging market debt from a country like Venezuela could be considered a yield trap. While the debt offers a good payout for those that take the risk, the tumultuous nature of the investment and the high chance that it will not be paid means it is too risky for most investors.

4. PE ratio

The price to earnings or PE ratio is one of the most important metrics to work out what something is worth compared to other investments. Some funds will hold a mix of PE ratios within their stocks, but other managers will lean towards lower or higher cohorts. Value investors typically look for a good deal – just like you might search through the sales section of John Lewis for something nice at half the price, value investors are looking for companies they believe the market is undervaluing.

The PE ratio is a great starting point for assessing value because it takes the current price of a share divided by the earnings the company has either made or is forecast to make over the coming year. If this ratio is low such as 12 or less, it indicates to value investors there could be an opportunity.

PE ratios vary by region and sector. Areas more associated with growth, such as tech companies in the US, will typically have higher PE ratios of 25 times forward earnings or more. This is because people are more focused on the earnings potential of these companies. On the other side, a utility company in the UK may have a much lower PE ratio because investors believe its earnings growth potential is modest.

If you want to understand how the PE ratio of a company has looked over time, you can use the CAPE or cyclically adjusted PE ratio. It shows the PE ratio across the past 10 years, and adjusts for inflation, so you can see in a single picture where the PE ratio sits now compared to historically. CAPE ratios aren’t always the easiest metric to gain access to, so it may be an option that is more for investors who pay for additional analytics services.

5. Sales growth

While value investors tend to prioritise ratios such as PE, growth investors will need to consider other metrics to decide if the higher price is worth the company’s potential. Sales growth shows the percentage change in the sales of a company over time. Typically, growth investors will go after a high (and positive) percentage change, but it’s not the only metric they consider. If you’re investing through a fund, it’s worth seeing which metric the fund tends to emphasise as this can be an indication of their philosophy.

There’s lots of metrics to consider when investing, but remembering the basics, like total return and investment fees, often still end up being the most important checks for investors to make.

Investment fees
Fees aren’t a metric, but they can make a massive impact on how your money grows. In addition, unlike investment performance, you’ll often know exactly how much you’ll be charged in fund fees throughout a year. Funds can have a large range of fees, and they aren’t always tied to performance. If you don’t do your due diligence, you could end up paying more for a fund that performs worse than its peers.
Funds that have experts choosing the holdings (called active funds) are typically more expensive than those that track an index (called passive funds). The average annual charge for an active fund that invests in global equities is 0.64%, while the average charge for a passive fund tracking global equities is 0.2%, according to FE Analytics. These fees may seem miniscule, but they make a difference over time.
For example, if you invested £10,000 in two funds that both had a return of 5% over 10 years, but one had a fee of 0.2% and one had a fee of 0.64%, you’d be out £712 because of that extra fee.

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