Next video:
Loading the player...

The price/earnings ratio is a stock’s price divided by its earnings per share. It works well for valuation, but not for evaluating potential returns among different investments. That’s where earnings yield comes in.

Earnings yield is EPS divided by the stock price. It’s the reciprocal of the P/E ratio. EPS is net income divided by outstanding shares, and it measures a company’s profitability.

If Stock A is trading at $10 and its EPS for the past year was 50 cents, it has a P/E of 20, and an earnings yield of 5%.

If Stock B is trading at $20 and its EPS is $2, its P/E ratio is 10, and its earnings yield is 10%.

B is the better value. Its P/E ratio is lower, and its earnings yield of 10% means that for every dollar invested, its stock generates 10 cents of earnings per share.

P/E ratios work best when they’re used to compare companies in the same sector, or the stock of one company over different periods of time. It’s also useful to compare the P/E to earnings growth or the PEG ratio. If a company has a P/E of 10 and earnings of 10%, its PEG ratio is 1. If another company has a P/E of 10 and earnings growth is 20%, its PEG is 0.5. It’s undervalued compared to the first.

  1. No results found.
Related Articles
  1. Investing

    Beware False Signals From the P/E Ratio

    The P/E ratio is a simple tool for evaluating a company, but it can also send false signals.
  2. 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.
  3. 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.
  4. 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.
  5. Investing

    Differences Between Forward P/E And Trailing P/E

    The most common types of price to earnings ratios are forward P/E and trailing P/E. Find out how they differ and the advantages and drawbacks of each.
  6. Trading

    Value-Priced Stocks to Watch in 2016 (AMBC, VIPS)

    In terms of P/E and Forward P/E these stocks are trading at low valuations. Watch these technical price levels for buying opportunities in 2016.
  7. Investing

    Profit With The Power Of P/E Ratio

    The P/E ratio is a valuable tool when deciding on an investment, but it's not the only thing to consider.
Hot Definitions
  1. IRR Rule

    A measure for evaluating whether to proceed with a project or investment. The IRR rule states that if the internal rate of ...
  2. Short Covering

    Short covering is buying back borrowed securities in order to close an open short position.
  3. Covariance

    A measure of the degree to which returns on two risky assets move in tandem. A positive covariance means that asset returns ...
  4. Liquid Asset

    An asset that can be converted into cash quickly and with minimal impact to the price received. Liquid assets are generally ...
  5. Nostro Account

    A bank account held in a foreign country by a domestic bank, denominated in the currency of that country. Nostro accounts ...
  6. Retirement Planning

    Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve ...
Trading Center