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The earnings yield is quoted as a percentage, allowing an easy comparison to going bond rates.
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. Some of this may result in dividends, while some may be kept as retained earnings. The market price of stocks may increase or decrease, 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.
Earnings Yield = (Earnings Before Interest & Taxes + Depreciation – CapEx) / Enterprise Value (Market Value + Debt – Cash)
This tells you how expensive a company is in relation to the earnings the company generates. When looking at Earnings Yield, we make certain adjustments to a company’s market capitalization to estimate what it would take to buy the entire company. This involves penalizing companies that have a lot of debt and rewarding others that have a lot of cash.