Earnings Yield
Earnings Yield is a very popular, and useful, tool for investors who try to beat the market with value stocks investing.
Earnings Yield
Earnings yield can help value stocks investors in their quest to find good solid companies that are currently relatively cheap. Using indicators like return on invested capital (learn how to calculate ROIC), can be helpful in finding a list solid companies, and once you’ve identified this list, earnings yield can help you determine if the company is cheap enough to buy right now, after all, that is what value stock investing is all about. Earnings yield does this by dividing a company’s annual earnings per share (you can use a trailing 4 quarters view of EPS for this if you’d like) by the company’s current market price per share. This number is expressed as a percentage, which makes it easy to compare with bond yields.
How to Calculate Earnings Yield
There are a couple of ways to calculate earnings yield. Since you don’t find this number in a lot of free online stock screeners, I’ll cover both methods, and you can decide which one you want to use.
The first way to calculate earnings yield is to take the inverse (1/x) of the P/E ratio. Since P/E ratios can be found in most financial publications, web sites, and stock screening tools, it is very easy to find this number, and invert it on a calculator or in a spreadsheet, to give you the earnings yield. This method is very simple to use, and gives you a quick view of how cheap (or expensive) a stock is.
The other way to calculate earnings yield is a little more involved, but gives you a better understanding of how a company is valued relative to it’s earnings. This form of earnings yield was written about by Joel Greenblatt in his book, “The Little Book That Beats the Market”. The earnings yield he created is useful in comparing companies with different tax rates and levels of debt. Greenblatt’s earnings yield formula is:
Earnings yield = pre-tax operating profit (EBIT) / Enterprise Value
So, in this case, the numerator (EBIT) comes from the income statement, and the denominator (Enterprise Value) is calculated by adding the market value of all equity – both common and preferred – to the value of all interest bearing debt that the company owes. The value of equity is just the shares outstanding multiplied by the price of the stock, and interest bearing debt can be found on the company’s balance sheet.
I like Greenblatt’s method of calculating earnings yield better than the more popular E/P method, since it gives a more accurate view of what is happening inside of a company, and also gives a more balanced view when comparing multiple companies to each other.
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