What Is Earnings Yield?
Let me explain earnings yield directly to you: it's the earnings per share from the last 12 months divided by the current market price per share. This metric, which is basically the flip side of the P/E ratio, shows what percentage of the stock price comes from earnings. You can use it to figure out optimal asset allocations, and it's handy for spotting if assets seem underpriced or overpriced.
Key Takeaways
- Earnings yield is the 12-month earnings divided by the share price.
- Earnings yield is the inverse of the P/E ratio.
- Earnings yield is one indication of value; a low ratio may indicate an overvalued stock, or a high value may indicate an undervalued stock.
- The growth prospects for a company are a critical consideration when using earnings yield. Stocks with high growth potential are typically valued higher and may have a low earnings yield even as their stock price rises.
How Earnings Yield Works
You should know how this plays out in practice. Money managers often stack the earnings yield of a big index like the S&P 500 against current interest rates, say the 10-year Treasury yield. If the earnings yield dips below that Treasury rate, stocks might be overvalued. But if it's higher, they could be undervalued compared to bonds.
Economic theory tells us that equity investors demand a risk premium—a few percentage points above risk-free rates like Treasury bills—in their earnings yield to make up for the extra risk of stocks over bonds. That's the straightforward logic you need to keep in mind.
Earnings Yield vs. P/E Ratio
Earnings yield isn't as popular as the P/E ratio for valuing investments, but it's useful when you're worried about return on investment. For you as an equity investor, growing your investment value over time might matter more than periodic income, which is why you might lean on P/E more often. Still, both metrics give you the same info, just presented differently.
Earnings Yield and Return Metric
If you're eyeing stocks for stable dividend income, earnings yield gives you a clear view of potential returns. Here, it's more about return than pure valuation—showing what the investment could earn for you. But remember, a valuation like P/E impacts this: an overvalued stock drops the yield, while an undervalued one boosts it.
As the stock price rises without matching earnings growth, yield falls; if price drops but earnings hold or rise, yield increases—that's what value investors chase. The inverse link to P/E means valuable investments have lower yields, and less valuable ones have higher yields. Growth investors bet on strong valuations leading to better future earnings and thus higher yields eventually, while weak valuations might drag yields down over time.
Example of Earnings Yield
Let me walk you through a real example to see if you'd buy or sell based on this. Back in April 2019, Meta (formerly Facebook) traded around $175 with 12-month earnings of $7.57, giving a 4.3% yield. That was high compared to its history, where it was 2.5% or less before 2018.
From 2016 to 2017, the stock jumped over 70%, and yield went from 1% to 2.5%. Then it dropped 40% from its 2018 peak, pushing yield to about 3%, and even over 5% in early 2019 as the price fell before rebounding.
That rising yield might have helped drive the recovery, as investors expected better earnings ahead. But a high yield didn't stop the 2018 drop. For older stocks with steady earnings and low expected growth, a higher-than-usual yield signals it might be oversold and ready for a bounce, assuming no bad company news.
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