What is earnings yield?
The earnings yield measures how much a company (or index) earns per dollar invested in its shares, expressed as a percentage. It is simply the inverse of the price-to-earnings (P/E) ratio and gives investors a quick way to compare the earnings “return” of stocks to yields on bonds or other cash instruments.
Key formula
– Earnings yield = Earnings per share (EPS, typically trailing 12 months) ÷ Current market price per share
– Expressed as a percentage: Earnings yield (%) = (EPS / Price) × 100
– Equivalent relation: Earnings yield = 1 ÷ (P/E ratio) (when the P/E uses the same EPS and price)
How earnings yield works (intuitively)
– A higher earnings yield means you receive more earnings for each dollar invested in the stock (or index); a lower yield means less earnings per dollar.
– Because it’s the inverse of P/E, a stock with a high P/E has a low earnings yield (growth/expensive), and a stock with a low P/E has a high earnings yield (value/cheaper by earnings).
– Investors often compare an equity earnings yield to prevailing fixed‑income yields (e.g., the 10‑year Treasury) to judge relative attractiveness. If equity earnings yield is lower than the risk‑free yield, equities may be relatively expensive; if higher, equities may be relatively cheap—subject to risk premium considerations.
Practical calculation examples
– Example A (single stock): EPS = $5.00; Price = $100.00
– Earnings yield = 5 / 100 = 0.05 → 5%
– Equivalent P/E = 100 / 5 = 20
– Example B (index comparison): If an index’s aggregate trailing earnings divided by the index level equals 4%, compare that 4% to current Treasury yields to help decide allocation.
Real‑world illustration
– Investopedia discusses Meta (formerly Facebook) trading near $175 in April 2019 with trailing 12‑month EPS ≈ $7.57, giving an earnings yield of about 4.3%. The article notes this was higher than prior years and that the yield rose further as the stock price declined into early 2019, illustrating how price moves alter the yield even if earnings stay constant (Investopedia; sources cited there: Nasdaq, Yahoo Finance).
Using earnings yield in investment decisions — practical steps
1. Gather inputs
– Obtain trailing‑12‑month EPS (or forward EPS if using forward yield) and current market price per share. For indices, use reported aggregate earnings and index level.
2. Compute the yield
– EPS ÷ Price → convert to percentage.
3. Decide whether to use trailing, forward, or normalized earnings
– Trailing earnings reflect actual historical results.
– Forward EPS uses analysts’ estimates (forward earnings yield).
– Normalized/adjusted EPS smooths cyclical or one‑time items for more stable comparisons.
4. Compare to benchmarks
– Compare to risk‑free rates (e.g., 10‑year Treasury). Consider the equity risk premium you expect (e.g., equities should yield X percentage points above Treasuries to justify extra risk).
– Compare to sector peers and historical averages for the stock or index.
5. Adjust for accounting and structural issues
– Watch for one‑time gains/losses, large share buybacks (which affect EPS), or accounting quirks that make EPS unreliable.
– For companies with negative earnings, use alternative metrics (EBIT/Enterprise Value or EBITDA/EV yield) rather than EPS/Price.
6. Use earnings yield alongside other metrics
– Combine with P/E trends, revenue growth, margins, free cash flow yield, and balance‑sheet strength. Earnings yield is a piece of the valuation puzzle, not a standalone verdict.
7. Make allocation or trading decisions
– If the stock/index earnings yield is materially higher than bonds plus your required equity risk premium and fundamentals support it, equities may be relatively attractive.
– If the yield is much lower than risk‑free rates plus required premium, consider being more cautious or seeking better‑valued opportunities.
When earnings yield is most useful
– Comparing stocks to bonds: It gives a simple, comparable percentage return to contrast with bond yields.
– Income‑oriented investors: Helps estimate potential earnings‑based returns (though dividends, buybacks, and payout policies determine realized cash return).
– Stable, mature companies: Works well where earnings are consistent; less helpful for high‑growth or highly cyclical firms without adjustments.
Limitations and cautions
– Earnings can be distorted by one‑time items, accounting choices, or cyclical swings—so naive EPS/Price comparisons can mislead.
– For companies with negative earnings, the metric is meaningless or misleading; use EBIT/EV or free‑cash‑flow yields instead.
– Earnings yield ignores growth: a low current yield may be justified if earnings are expected to grow rapidly.
– Sector differences: Some sectors naturally produce different yields (e.g., utilities vs. tech), so compare within sectors.
– Market dynamics and expectations: A high earnings yield might reflect market fears about future earnings deterioration rather than an outright bargain.
Advanced variants
– Enterprise‑value earnings yield: EBIT ÷ Enterprise Value (EV) or EBITDA ÷ EV. These are useful when capital structure differences, non‑operating items, or negative EPS make basic earnings yield less reliable.
– Forward earnings yield: Uses analysts’ forecast EPS divided by current price to capture expected earnings changes.
Checklist for investors (quick decision guide)
– Calculate trailing and forward earnings yields.
– Check recent earnings quality and identify one‑offs.
– Compare the yield to 10‑year Treasury yield and decide your required risk premium.
– Compare to sector and historical yields.
– If negative earnings, switch to EBIT/EV or FCF/EV yield.
– Combine with growth and cash‑flow analysis before committing.
– Reassess periodically because price and earnings change.
Summary
Earnings yield (EPS ÷ price) is a straightforward, intuitive way to express the earnings “return” on equity and is the reciprocal of the P/E ratio. It’s useful for comparing stocks with bonds, for screening value opportunities, and for assessing income‑type return potential in stable businesses. However, it should never be used in isolation—adjust for accounting distortions, cyclical effects, and growth expectations, and consider enterprise‑value based yields when EPS is distorted or negative.
Sources
– Investopedia: “Earnings Yield” — https://www.investopedia.com/terms/e/earningsyield.asp (includes references to Nasdaq and Yahoo Finance data used in the article example).