Earnings yield is a fundamental financial metric that measures the profitability of a company relative to its current stock price. It provides investors with valuable insights into the potential return they can expect from investing in a particular stock. In this article, we will delve into the definition, formula, and calculation of earnings yield, compare it with bond yield, and explore its significance in value investing.
What is Earnings Yield?
Earnings Yield Definition
Earnings yield is defined as the ratio of a company’s diluted earnings per share (EPS) over the trailing twelve months (TTM) to its current stock price. In other words, it indicates how much the company has earned per share as a percentage of its share price.
The earnings yield informs investors about the yield they are receiving in earnings for owning the stock at its current market price. It provides a measure of the stock’s profitability and valuation, allowing investors to assess whether the stock is undervalued or overvalued compared to its earnings.
Earnings Yield Formula
The formula for calculating earnings yield is as follows:
| Earnings Yield = Diluted Earnings Per Share (TTM) / Current Stock Price |
The diluted earnings per share used in the formula takes into account all potential shares that could be issued, such as stock options and convertible securities. This provides a more conservative measure of earnings compared to basic EPS.
The trailing twelve months refers to the timeframe of the past twelve months used for financial reporting. It ensures that the earnings yield calculation is based on the most recent and relevant earnings data.
How to Calculate Earnings Yield
Earnings Yield Calculation Steps
To calculate the earnings yield of a stock, follow these steps:
- Determine the company’s diluted earnings per share (EPS) for the trailing twelve months. This information can be found in the company’s financial statements or on financial websites.
- Obtain the current stock price of the company. This is the market price at which the stock is currently trading.
- Divide the diluted EPS (TTM) by the current stock price to calculate the earnings yield.
For example, if a company has a diluted EPS (TTM) of $2.50 and its current stock price is $50, the earnings yield would be:
| Earnings Yield = $2.50 / $50 = 0.05 or 5% |
Earnings Yield Calculation Example
Let’s consider a real-world example to illustrate the earnings yield calculation. Suppose XYZ Company has the following financial information:
- Diluted EPS (TTM): $4.20
- Current Stock Price: $60
Using the earnings yield formula, we can calculate:
| Earnings Yield = $4.20 / $60 = 0.07 or 7% |
This means that for every dollar invested in XYZ Company’s stock at the current price, an investor would receive $0.07 in earnings over the trailing twelve months.
Earnings Yield vs. Bond Yield
Comparing Earnings Yield and Bond Yield
Earnings yield is often compared to bond yield, particularly the yield on 10-year Treasury notes, to assess the relative attractiveness of stocks and bonds. When the earnings yield on stocks is higher than the bond yield, it suggests that stocks may be undervalued and offer a better investment opportunity.
On the other hand, when the bond yield exceeds the earnings yield, it may indicate that stocks are overvalued and bonds provide a more attractive risk-adjusted return. Investors can use this comparison to make informed decisions about asset allocation and portfolio management.
Historical Analysis of Earnings Yield vs Bond Yield
A historical analysis of the relationship between earnings yields on equities and Treasury yields reveals interesting patterns. From 1946 to 1967, earnings yields were consistently higher than Treasury yields, indicating a favorable environment for stock investing. This period was characterized by robust economic growth and relatively low inflation.
However, from 1968 to 2008, earnings yields and Treasury yields moved in tandem, with occasional divergences. This period witnessed market crashes, economic recessions, and fluctuating inflation rates, impacting the relative performance of stocks and bonds.
In recent years, from 2009 to 2022, earnings yields have once again surpassed Treasury yields, suggesting a renewed attractiveness of stocks. Nonetheless, investors must consider the broader economic context, including inflation expectations and market valuations, when making investment decisions.
Earnings Yield and Value Investing
Using Earnings Yield to Find Undervalued Stocks
Value investing is an investment strategy that involves identifying assets trading below their intrinsic worth and buying them at a bargain. Earnings yield plays a crucial role in value investing, as it helps investors identify potentially undervalued stocks.
A high earnings yield indicates that a stock is generating significant earnings relative to its price, suggesting that it may be undervalued. Value investors use earnings yield in conjunction with other financial metrics and qualitative factors to make informed investment decisions.
By comparing the earnings yield of a stock to its historical levels, industry peers, and the broader market, value investors can gain a more nuanced understanding of the stock’s valuation and potential for future appreciation.
High Earnings Yield Stock Examples
Let’s look at some examples of stocks with high earnings yields that may be of interest to value investors:
- Hanesbrands Inc. (HBI): This apparel company has a high earnings yield and a Zacks Rank of #1, indicating a strong buy recommendation. Hanesbrands focuses on innerwear growth and cost reduction initiatives, leading to high estimated earnings growth.
- Royal Caribbean Cruises (RCL): The cruise line operator boasts a high earnings yield and a Zacks Rank of #1. Royal Caribbean benefits from strong booking trends and investments in digital travel platforms, positioning it for growth.
- Allstate Corporation (ALL): This insurance company has a high earnings yield and a Zacks Rank of #1. Allstate sees growth in premiums, implements cost-saving initiatives, and generates strong cash flows, making it an attractive value pick.
- Aptiv PLC (APTV): Aptiv, a technology company in the automotive sector, has a high earnings yield and a Zacks Rank of #1. It leverages technology trends in the automotive industry for growth and has strong earnings growth estimates.
Value investors can access a full list of high earnings yield stocks using research tools like the Research Wizard software, which facilitates stock picking and backtesting.
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