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.
Related Terms with Definitions
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
Suggested Books for Further Reading
- “Financial Ratios for Executives: How to Assess Company Strength, Fix Problems, and Make Better Decisions” by Michael Rist
- “Security Analysis” by Benjamin Graham and David Dodd
- “The Intelligent Investor” by Benjamin Graham
- “Financial Statement Analysis and Security Valuation” by Stephen H. Penman
Accounting Basics: “Earnings Yield” Fundamentals Quiz
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