Everybody has suddenly become obsessed with valuations,
specifically the P/E ratio. Many are wringing their hands over the
P/E being as high now as it was in late 2009.
One of two things will happen: either stocks will go down and
correct this, or earnings will go up and address it that way. We
all know what happened in 2009. Earnings rose, pushing valuations
down ... and the market has been going up ever since.
We of course need to keep our eyes on valuations. But, we should
also pay attention to the earnings yield as well.
A stock's earnings yield measures just that, the anticipated yield
(or return) an investment in a stock could give you based on the
earnings and the price paid for the stock.
The calculation is the inverse of the P/E ratio:
The P/E of course is the Price / Earnings
So a stock trading at a Price of $35 with Earnings of $3 has a P/E
ratio of 11.67. This means it's selling at 11.67 times earnings.
Another way of looking at it is you're paying $11.67 for $1 of
The Earnings Yield is calculated as Earnings / Price
Using the example above, a stock with $3 of Earnings trading at a
Price of $35 ($3 / $35) has an earnings yield of 0.0857 or 8.57%.
The Earnings Yield, also known as the E/P Ratio, is expressed as a
percentage. So a yield of 8.57% would also mean 8.57 cents of
earnings for $1 of investment.
Of course, this is all potential, because prices and earnings
How To Use It
The most common way people will use this ratio is to compare it to
other stocks and to compare the yields to the 10 Year T-Bill.
Conventional wisdom has it that if the yield on the stock market
(S&P 500 for example) is lower than the yield on the 10 Year
Treasury, then stocks might be considered overvalued.
If the yield on the S&P 500 is greater than the 10 Year T-Bill,
stocks would be considered undervalued.
The theory behind this is that Bonds and Stocks are competing for
investors' dollars. And to attract investment interest in stocks, a
higher yield needs to be paid to the stock investor for the extra
risk he or she is assuming compared to the virtual risk-free
investment offered in US-backed Treasuries.
If earnings go up, the yield goes up. If earnings go down, so does
Prices also impact the yield, but they move inversely. If Prices go
up, the yield goes down. And if prices go down, the yield goes up.
Forecasting Market Upturns and Downturns with the Earnings
In June of 2007, the yield on the 10 Yr. T-Bill was 4.95%.
However, the earnings yield on the S&P 500 was 4.19%.
Not much of a risk premium on a risk based investment.
Remember, if the earnings yield on stocks is below the T-Bill rate,
stocks are considered overvalued. (I should point out that within
months, the market began to falter.)
I also happened to write about the earnings yield in March of 2009.
This time, the earnings yield was high. Back then, the earnings
yield on the S&P 500, using the 12 Month Projected Earnings
Estimate, was 9.51%, compared to the 10 Yr. Treasury of 2.89%.
With yields well above the 10 Year, conventional wisdom said that
stocks were 'undervalued'. Of course, they could have continued to
get more undervalued. But the market was quickly bid up - resulting
in one of the largest rallies we've ever seen.
So where is it now?
Currently, the earnings yield for the S&P is 6.35%, compared to
the 10 Year Treasury of 2.84%.
So stocks are still the more attractive investment, assuming you're
ok with the risk that comes along with it.
The screen I'm running today looks for the following:
Price greater than or equal to $5
Volume (Avg. 20 Day Shares) greater than or equal to
Earnings Yield greater than or equal to 7%
(For those using the Research Wizard, the calculation looks
That's the 12 Month Forward Looking Estimate (i642) divided
by the Current Price (i5))
12 Month Projected Growth Rate greater than or
equal to S&P 500
Zacks Rank less than or equal to 2
Here are 5 stocks from this week's screen (for Tues., 1/14/14):
(7.08% Earnings Yield)
(8.66% Earnings Yield)
(8.63% Earnings Yield)
(10.65% Earnings Yield)
(7.54% Earnings Yield)
Get the rest of the stocks on this list and start using the
Earnings Yield in your own screens. Find the stocks that can give
you the best returns. You can do it.
Click here to sign up for a free trial to the
Research Wizard today.
Disclosure: Officers, directors and/or employees of Zacks
Investment Research may own or have sold short securities and/or
hold long and/or short positions in options that are mentioned in
this material. An affiliated investment advisory firm may own or
have sold short securities and/or hold long and/or short positions
in options that are mentioned in this material.
Disclosure: Performance information for Zacks' portfolios and
strategies are available at:
ACTAVIS PLC (ACT): Free Stock Analysis Report
ASPEN INS HLDGS (AHL): Free Stock Analysis
AEGEAN MARINE (ANW): Free Stock Analysis Report
TRINITY INDS IN (TRN): Free Stock Analysis
UTD RENTALS INC (URI): Free Stock Analysis
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