What Is Earnings Yield? Meaning and How to Calculate & Use It

Earnings Yield is a financial ratio that measures the amount of a company's earnings relative to its market value. It is calculated by dividing the company's earnings per share (EPS) by its current market price per share. The earnings yield can be thought of as the inverse of the price-to-earnings (P/E) ratio, which is a commonly used measure of a stock's valuation.

Understanding Earnings Yield

Calculation

Earnings Yield is calculated by dividing the earnings per share (EPS) by the current market price of the stock, then multiplying by 100 to get a percentage. The formula looks like this:

$$\text{Earnings Yield} = \left( \frac{\text{EPS}}{\text{Market Price per Share}} \right) \times 100$$

Importance

• Investment Comparison: It offers a straightforward way for investors to compare the earnings potential of a stock against other investment vehicles, like bonds or other stocks.
• Value Indicator: A high earnings yield can indicate that a stock is undervalued or that the company is generating substantial earnings relative to its share price.

Application of Earnings Yield

Analyzing Investment Opportunities

Investors often use earnings yield as a tool for assessing whether a stock is priced attractively compared to its earnings. For instance:

• Stock vs. Bonds: Investors might compare the earnings yield of a stock to the yield of a government bond. If the stock’s earnings yield is higher, they might consider it a better investment opportunity, assuming they are comfortable with the higher risk associated with stocks.
• Portfolio Construction: Within a portfolio, investors can prioritize stocks with higher earnings yields to increase the overall income-generating potential of their investments.

Example: Infosys

Let's say Infosys has an EPS of ₹50, and its current market price is ₹1000 per share. The earnings yield would be calculated as follows:

$$\text{Earnings Yield} = \left( \frac{50}{1000} \right) \times 100 = 5\%$$

This means that for every ₹100 invested in Infosys shares, the company generates ₹5 in earnings. Investors can use this information to compare Infosys with other investment opportunities.

Earnings Yield vs. P/E Ratio

While the P/E Ratio gives you an idea of what the market is willing to pay for a company’s earnings, the Earnings Yield provides a direct insight into how much earnings a stock can generate for each rupee invested in it. In essence, while both provide valuable insights, the choice between using earnings yield and P/E ratio can depend on the investor's preference for assessing value.

Conclusion

Earnings Yield is a key metric for investors focusing on the income or return aspect of stocks. It helps in comparing different investment options on a relative basis and identifies potentially undervalued stocks. As with any investment metric, it's most effective when used in conjunction with other analyses and indicators to build a well-rounded view of an investment's attractiveness. Investors are advised to consider various factors, not just earnings yield alone, to make informed decisions.