The nice thing about Earnings Yield, as opposed to P/E, is that we can compare it with alternative investments such as fixed deposits, to see what kind of a return we can expect from an investment.
The first yield based measure is what is called the Earnings Yield. In addition to multiple-based measures, you can also use yield-based measures to value stocks. If we invert the P/E and divide a firm’s earnings per share by its market price, we get an earnings-yield. If a stock sells for Rs. 200 per share and has Rs.10 in earnings, it has a P/E of 20 (20/1) but an earnings-yield of 5% (1/20).
Earnings Yield Formula
Earnings Yield = Earnings per share / current market price
The nice thing about yields, as opposed to P/Es, is that we can compare them with alternative investments such as fixed deposits, to see what kind of a return we can expect from each investment. (The difference is that earnings generally grow over time, whereas fixed deposit payments are fixed).
A stock with a P/E of 20 would have a yield of 5 percent which is worse than the current bank FD rate of 8%. A stock with a P/E of 10, however, will have a yield of 10% which is better than the FD rates. Thus I might be induced to take the additional risk.
You may also like to learn more on yield-based and other valuation measures, as below.