Earnings Yield

Definition

Earnings yield is a financial ratio that compares the earnings per share (EPS) of a company to the market price per share. It is expressed as a percentage and represents the percentage of each dollar invested in the stock that was earned by the company. It is calculated as follows:

\[ \text{Earnings Yield} = \left( \frac{\text{EPS}}{\text{Market Price per Share}} \right) \times 100 \]

Explanation

Earnings yield serves as an inverse of the Price-Earnings (P/E) ratio. While the P/E ratio expresses how much investors are willing to pay per dollar of earnings, the earnings yield shows what percentage of the stock price is being earned per share by the company. It essentially indicates the return on investment for shareholders.

Examples

Company A:
- Earnings Per Share (EPS): $5
- Market Price Per Share: $100
- Earnings Yield: $ \left( \frac{5}{100} \right) \times 100 = 5% $
Company B:
- Earnings Per Share (EPS): $2
- Market Price Per Share: $40
- Earnings Yield: $ \left( \frac{2}{40} \right) \times 100 = 5% $
Company C:
- Earnings Per Share (EPS): $10
- Market Price Per Share: $200
- Earnings Yield: $ \left( \frac{10}{200} \right) \times 100 = 5% $

Frequently Asked Questions (FAQs)

Q: How does earnings yield differ from the P/E ratio?

A: The earnings yield is the inverse of the P/E ratio. While the P/E ratio shows how much investors are willing to pay per dollar of earnings, the earnings yield shows the return rate based on the current share price.

Q: Why is earnings yield important for investors?

A: Earnings yield provides investors with a quick way to compare the profitability of different companies and to understand what proportion of their investment is backed by earnings. It can help in making investment decisions, especially when comparing bonds and stocks.

Q: Can earnings yield be used to compare companies in different industries?

A: Yes, but it should be done with caution. Different industries have different growth potentials and risk profiles, which can affect the appropriate earnings yield for companies within those industries.

Q: What does a high earnings yield indicate?

A: A high earnings yield may indicate that a stock is undervalued or that the company is generating significant earnings relative to its stock price. However, it could also be a sign of higher risk or lower growth prospects.

Q: What about a low earnings yield?

A: A low earnings yield could suggest that a stock is overvalued or that the company is reinvesting a significant amount of its earnings for growth, leading to lower immediate returns on investment.

Price-Earnings (P/E) Ratio: A valuation ratio of a company’s current share price compared to its earnings per share (EPS). It shows how much investors are willing to pay today for a dollar of earnings.
Earnings per Share (EPS): A company’s profit divided by the number of outstanding shares of its common stock, indicating a company’s profitability on a per-share basis.
Dividend Yield: The dividend per share, divided by the price per share. It shows how much a company pays out in dividends each year relative to its stock price.

Online References

Accounting Basics: “Earnings Yield” Fundamentals Quiz

### How is earnings yield calculated? - [x] EPS divided by Market Price per Share and multiplied by 100 - [ ] EPS multiplied by Market Price per Share - [ ] Market Price per Share divided by EPS and multiplied by 100 - [ ] Market Price per Share multiplied by EPS > **Explanation:** Earnings yield is calculated by dividing the earnings per share (EPS) by the market price per share and then multiplying by 100 to express it as a percentage. ### What does a high earnings yield generally indicate? - [x] A stock might be undervalued or has high earnings relative to its price - [ ] A stock is guaranteed to be a good investment - [ ] A company is overvalued - [ ] A company is experiencing high growth > **Explanation:** A high earnings yield may indicate that a stock is undervalued or that the company has high earnings relative to its price, making it attractive to potential investors. ### Which of the following is the inverse of the earnings yield? - [ ] Dividend Yield - [ ] Return on Equity - [x] Price-Earnings (P/E) Ratio - [ ] Debt to Equity Ratio > **Explanation:** The Price-Earnings (P/E) ratio is the inverse of the earnings yield. While earnings yield shows the return on investment, the P/E ratio shows how much investors are willing to pay per dollar of earnings. ### Earnings yield is expressed as: - [x] A percentage - [ ] A dollar amount - [ ] A ratio - [ ] An index > **Explanation:** Earnings yield is expressed as a percentage, representing the proportion of the stock price that is earned by the company. ### What is the primary use of earnings yield for investors? - [ ] To assess company's debt structure - [x] To evaluate the profitability of a company relative to its share price - [ ] To measure company's dividend policy - [ ] To forecast future earnings > **Explanation:** The primary use of earnings yield is to evaluate the profitability of a company relative to its share price, aiding investors in making informed investment decisions. ### Which type of stocks might have lower earnings yields as a common characteristic? - [ ] Mature companies - [ ] Value stocks - [x] Growth stocks - [ ] Cyclical stocks > **Explanation:** Growth stocks often have lower earnings yields as they tend to reinvest earnings for future expansion, resulting in lower immediate returns to investors. ### What does EPS stand for in the earnings yield formula? - [ ] Earnings Per Stock - [ ] Equity Payment Share - [x] Earnings Per Share - [ ] Earnings Percentage Standard > **Explanation:** EPS stands for Earnings Per Share, which is used in the earnings yield formula to calculate the company's profitability on a per-share basis. ### What element is compared against EPS in the earnings yield formula? - [ ] Dividends per share - [x] Market price per share - [ ] Earnings before interest and tax - [ ] Shareholder's equity > **Explanation:** Market price per share is compared against EPS in the earnings yield formula to represent how much earnings each dollar invested in the stock will generate. ### Why might a company with a high earnings yield still be considered a risky investment? - [ ] High earnings yield reduces stock price - [ ] Earnings yield is irrelevant - [ ] High earnings yield means high P/E ratio - [x] A high earnings yield might reflect underlying issues or market skepticism > **Explanation:** A high earnings yield might reflect underlying issues or market skepticism about the company's future, thus making it a potentially risky investment. ### Which of the following ratios is closely related to earnings yield for understanding stock value? - [ ] Current Ratio - [ ] Quick Ratio - [ ] Debt-Equity Ratio - [x] Price-Earnings (P/E) Ratio > **Explanation:** The Price-Earnings (P/E) ratio is closely related to earnings yield and is used in conjunction to understand stock value and investment profitability.

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