What is 'Earnings Yield'

The earnings yield refers to the earnings per share for the most recent 12-month period divided by the current market price per share. The earnings yield (which is the inverse of the P/E ratio) shows the percentage of each dollar invested in the stock that was earned by the company. This yield is used by many investment managers to determine optimal asset allocations.

BREAKING DOWN 'Earnings Yield'

Money managers often compare the earnings yield of a broad market index (such as the S&P 500) to prevailing interest rates, such as the current 10-year Treasury yield. If the earnings yield is less than the rate of the 10-year Treasury yield, stocks as a whole may be considered overvalued. If the earnings yield is higher, stocks may be considered undervalued relative to bonds.

Economic theory suggests that investors in equities should demand an extra risk premium of several percentage points above prevailing risk-free rates (such as rates on Treasury bills) in their earnings yield to compensate them for the higher risk of owning stocks over bonds and other asset classes.

Earnings Yield vs. P/E Ratio

Earnings yield as an investment valuation metric is not as widely used as its P/E ratio (price-earnings ratio) inverse in stock valuation. Earnings yield can be useful when concerned about the rate of return on an investment. For equity investors, however, earning periodic investment income may be secondary to growing their investments' values over time. This is why investors may refer to value-based investment metrics such as P/E ratio more often than earnings yield when making stock investments.

Earnings Yield and Return Metric

For investors looking to invest in stocks with stable dividend income, earnings yield can offer a direct look into the level of return such dividend stocks may generate. In this case, earnings yield is more of a return metric about how much an investment can earn back for investors, rather than a valuation metric about how much the investment is valued in the market by investors. However, a valuation metric such as P/E ratio can affect a return metric like earnings yield. An overvalued investment can lower earnings yield and, conversely, an undervalued investment can raise earnings yield.

Earnings Yield and Valuation Metric

The inverse relationship between earnings yield and P/E ratio seem to indicate that the more valuable an investment is, the lower the earnings yield may be, and the less valuable an investment is, the higher the earnings yield may be. In reality, however, investments with strong valuations and high P/E ratios might generate more earnings over time and eventually boost up their earnings yield. On the other hand, investments with weak valuations and low P/E ratios might generate less earnings over time and, in the end, drag down their earnings yield.

Read about the Earnings Per Share and its real world applications here.

RELATED TERMS
  1. Bond Equity Earnings Yield Ratio ...

    The Bond Equity Earnings Yield Ratio (BEER) is a metric used ...
  2. Average Annual Yield

    The average yield on is the sum of all interest, dividends or ...
  3. Gross Yield

    The gross yield is the yield on an investment before the deduction ...
  4. Yield On Cost (YOC)

    Yield on Cost (YOC) is the annual dividend rate of a security ...
  5. Yield Spread

    A yield spread is the difference between yields on differing ...
  6. Indicated Yield

    Indicated yield is the dividend yield that a share of stock would ...
Related Articles
  1. Investing

    How to Find P/E And PEG Ratios

    If calculating the P/E and PEG ratios have you in the dark, these easy calculations should help.
  2. Investing

    How To Use The P/E Ratio And PEG To Tell A Stock's Future

    The P/E ratio is used to calculate stock price valuation. However the PEG ratio includes earnings growth and can provide insight as to whether the P/E valuation is justified.
  3. Investing

    PEG Ratio Nails Down Value Stocks

    Learn how this simple calculation can help you determine a stock's earnings potential.
  4. Investing

    Understanding the Different Types of Bond Yields

    Any investor, private or institutional, should be aware of the diverse types and calculations of bond yields before an actual investment.
  5. Insights

    Why the 10-Year U.S. Treasury Yield Matters

    10-year treasury bond yields are important indicators of the economy as a whole.
  6. Investing

    The 4 basic elements of stock value

    Investors use these four measures to determine a stock's worth. Find out how to use them.
  7. Investing

    How Often the 10-Year Yield Underperforms the S&P 500

    Learn why the S&P 500 Index dividend yield exceeds the yield on 10-year U.S. Treasurys for only the third time in history and why this trend might end soon.
  8. Investing

    Are stocks with low P/E ratios always better?

    Is a stock with a lower P/E ratio always a better investment than a stock with a higher one? The short answer is no. The long answer is it depends.
  9. Investing

    Can Investors Trust The P/E Ratio?

    The P/E ratio is one of the most popular stock market ratios, but it has some serious flaws that investors should know about.
RELATED FAQS
  1. How do I calculate the P/E ratio of a company?

    The P/E ratio shows whether a company's stock price is overvalued or undervalued and can reveal how a stock's valuation compares ... Read Answer >>
  2. Can stocks have a negative price-to-earnings ratio?

    A stock can have a negative price-to-earnings ratio (P/E). A negative P/E ratio means the company has negative earnings or ... Read Answer >>
  3. The Average Price-To-Earnings Ratio in the Oil & Gas Drilling Sector

    Investing in the energy sector provides an opportunity for value investors, but it is necessary to understand metrics such ... Read Answer >>
  4. What common growth rates should be analyzed when considering the future prospects ...

    Learn about some of the most commonly used measures for evaluating a company's future growth prospects and analyzing it as ... Read Answer >>
  5. How are bond yields affected by monetary policy?

    Learn about how bond yields are affected by monetary policy. Find out how this determines the risk-free rate of return and ... Read Answer >>
Trading Center