What is Earnings Yield?
352 reads · Last updated: December 5, 2024
The earnings yield refers to the earnings per share for the most recent 12-month period divided by the current market price per share. The earnings yield (the inverse of the P/E ratio) shows the percentage of a company's earnings per share. Earnings yield is used by many investment managers to determine optimal asset allocations and is used by investors to determine which assets seem underpriced or overpriced.
Definition
Earnings yield is calculated by dividing the earnings per share (EPS) of the last 12 months by the current share price. It is the inverse of the price-to-earnings (P/E) ratio and shows the percentage of earnings per share. Investors use earnings yield to assess the investment value of a company's stock.
Origin
The concept of earnings yield originates from the use of the P/E ratio, a common metric for evaluating the value of a company's stock. As investment analysis evolved, investors began focusing on the inverse of the P/E ratio, the earnings yield, for a more direct understanding of investment returns.
Categories and Features
Earnings yield can be categorized into historical earnings yield and expected earnings yield. Historical earnings yield is based on past financial data, while expected earnings yield is based on future earnings forecasts. Historical earnings yield provides an assessment of past performance, whereas expected earnings yield helps investors predict future investment returns.
Case Studies
Case Study 1: During the 2008 financial crisis, many companies saw their earnings yields rise significantly as stock prices plummeted while earnings remained relatively stable. For example, a major bank's earnings yield increased from 5% to 10% during the crisis, attracting value investors. Case Study 2: During the 2020 pandemic, tech companies generally had low earnings yields because stock prices soared beyond earnings growth. For instance, a well-known tech company's earnings yield dropped from 3% to 1.5%, reflecting high market expectations for its future growth.
Common Issues
Investors often misconstrue high earnings yield as indicative of high investment returns, but in reality, a high earnings yield may reflect market concerns about a company's future profitability. Additionally, earnings yield does not account for a company's debt levels or changes in market conditions, so it should be analyzed alongside other metrics.
