Understanding Earnings Yield

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.

Contents
  1. Earnings Yield
    1. Earnings Yield Formula

 

Earnings Yield

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.

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