Business, Legal & Accounting Glossary
The Earnings Yield is a metric used by investors to assess the investment in a company relative to other companies and assets such as fixed income (bonds or treasury bills). The earnings yield is the reciprocal of the P/E ratio and indicates the money earned by the company relative to dollars invested in the stock.
In the earnings yield computation, trailing 12-month earnings is typically used. For example, if earnings per share for the past four quarters is $3 and the stock price is $30, the earnings yield is 10%.
The earnings yield is the reciprocal of the price to earnings ratio, which would be 30/3, or 10. Inverse to the P/E, a high earnings yield might indicate a stock is undervalued, and a low earnings yield might indicate a stock is overvalued. Some market pros use earnings yield instead of P/E because they find a percentage indicator clearer.
Moreover, because earnings yield is expressed as a percentage, it can be compared to the yield on other investments, like bonds. But be cautious of simplistic uses of the earnings yield.
A stock’s value reflects the return for all future periods (appropriately discounted), not just that for a single year.
Moreover, growth stocks with strong potential but few earnings will have a very low earnings yield, yet may not be overvalued.
A variant on the earnings yield is the projected earnings yield. This figure uses the mean estimated (projected) net earnings for the current year, next year or combination of both current and next. The estimated earnings are provided by analysts from various financial publications.
Analysts often compare the earnings yield of the S&P 500, NYSE or other broad equities market to the interest rates offered on other assets, such as the 10-year Treasury yield or long term Treasury Bonds.
Generally, the earnings yield of equities is higher than for fixed income assets, reflecting the added risk involved with equities. After accounting for risk, the yield between the two assets should be similar. If not then the securities market is considered either over or undervalued.
The earnings yield may also be used as a value metric by comparing the yield of one company to another. This is typically done by quantitative analysts and value investors.
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This glossary post was last updated: 22nd March, 2020 | 0 Views.