What is Earnings Yield?
Earnings yield is earnings per share from the last year, can be calculated by dividing the dividend earnings per share per year (earnings per share, also known as EPS) by share market price. The earnings yield quoted as a percentage which is the percentage that’s the investor will earn from the stock market (or a single stock, a sector) within the past year.
The earnings yield is a tool for evaluate a return rate of a stock market, a sector, or single stock per year. The investors use the earnings yield to compared against yield from other markets such as gold, government bonds, or any other assets to decide where to allocate their investment.
Normally, the earnings yield is used to compare with 10-year government bond yield to evaluate which market is better for investment. If the earnings yield is lower than the 10-year bond yield, then the investors will allocate their funds into bonds instead of investing in stocks.
- Earnings yield is a ratio for evaluate how many percentage the investor earned from a stock.
- The earnings yield can be used for a comparision against 10-year Treasury bond yield to which is better perform. Normally, the stocks earnings yield are higher than the goverment bonds which is risk-free investment.
- The earnings yield can be calculated by dividing the earnings per share (EPS) from last 12 months by the share price. In fact, it is the reverse version of the P/E ratio.
- A lower earnings yield indicate an overvalued stock since higher stock prices lower the earnings yield, while a higher indicate an undervalued stock.
How to Calculate the Earnings Yield
The earnings yield of a single stock can be calculated by dividing the dividend earnings per share per year by the stock’s market price. While the earnings yield of a stock market can be calculated by dividing the market’s dividend earning by the stock market price.
Earnings Yield = (Earning / Market Price) x 100
- Earning — stock’s dividend per share per year (earnings per share, also known as EPS).
- Market Price — the current market price of the stock.
For example, an Apple stock is currently $175 per share, last year it paid a dividend $7.5 per share. Then, Apple’s current Earnings Yield is 4.3%.
Look familiar? The earnings yield is a reciprocal version of the Price to Earnings Ratio (also known as the P/E Ratio). In case you know a market P/E, then it can be calculated by divided 1 by P/E ratio.
Earnings Yield = (1 / PE ratio) x 100
How Earnings Yield Works?
Earnings yield reflects the value of a stock (or a market) when compared to other companies in the same sector; a low earnings yield indicates an overvalued stock since higher stock prices lower the earnings yield, while a high earnings yield indicates an undervalued stock.
Also, the earnings yield can be used for comparison against different asset classes. Typically, compare against 10-year Treasury bond yield (or 30-year) to reflect how expensive stocks are, and which one have a better performance. Normally, the stocks’ earnings yields are higher than the government bonds which is risk-free investment.
The earnings yield helps investors know how much he has earned per share. If it’s lower than the 10-year Treasury bond yield, investors prefer to invest in a government bond which is a risk-free asset. In contrast, the higher earnings yield will attract the investors to invest in stock (or other risk assets) instead.
Put it simply, it’s a tool to indicate a good time to invest in the stock or allocate investment to another asset class.