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The earnings yield is quoted as a percentage, allowing an easy comparison to going bond rates.
What is Earnings Yield? It’s an estimate interest rate, that you may earn from holding a stock, assuming the company’s earnings do not grow in the future. A stock with low P/E Ratio will have high Earnings Yield and vice-versa.
What is the Formula to Calculate Earnings Yield? Earnings Yield = 1 ÷ P/E Ratio or ( EPS ÷ Price ) * 100
How Earnings Yield is Useful? Earnings yield can be compared with other asset classes, like fixed deposits, bonds, etc.… This comparison can help in selecting, the best investment option at that point in time. The interest on fixed deposit is fixed, but for a company’s earnings, sky is the limit. How to Spot Bargains using Earnings Yield? A bargain arises, when Earnings Yield of stock is higher, than the prevailing interest rate from other asset classes.
The earnings yield can be used to compare the earnings of a stock, sector or the whole market against bond yields. Generally, the earnings yields of equities are higher than the yield of risk-free treasury bonds reflecting the additional risk involved in equity investments. The average P/E ratio for U.S. stocks from 1900 to 2005 is 14, which equates to an earnings yield of over 7%.
Earnings yield is one of the factors discussed in Joel Greenblatt's The Little Book That Beats the Market. However, Greenblatt uses an adjusted earnings yield formula to account for the fact that different companies have different debt levels and tax rates.