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.

Technorati Tags: Array, Bond Rates, Bond Yields, Calculator, Citation, Current Market, Earnings Per Share, Earnings Yield, Earnings Yields, Eps, Equity Investments, Expansion Capital, Financial Publications, Investors, Joel Greenblatt, Operating Profit, Quarters, Ratios, Return On Invested Capital, Spreadsheet, Stock Investing, Stock Screeners, Stock Screening Tools, Stock Sector, Tax Rates, Treasury Bonds, Value Investing, Value Stock, Value Stocks

Equity Growth Rate

Equity growth rate for any company is also known as the book value growth rate.  Equity is what is left over when liabilities are subtracted from assets on a company’s balance sheet.  Equity represents what is left over if a company is liquidated and ceases to exist.  The equity growth rate is the percentage that equity per outstanding share of stock (or book value per share) has grown over the last year.  Equity grows when a business accumulates surplus profits.  Think about it – many profitable businesses have to use their earnings to fund their growth, either by building new stores, replacing old or worn out capital equipment, etc.  Businesses that accumulate excess profits while still growing are special indeed!  We use equity growth rate to find these great businesses.

How to Calculate Equity Growth Rate

Learning how to calculate equity growth rate is a great companion for the other skill you learned for finding great investments when you learned how to calculate ROIC.  Equity growth rate is calculated by dividing this years book value per share by last years book value per share, the subtracting 1:

Equity Growth Rate = BVPS(today)/BVPS(last year) – 1

Equity growth rate is represented as a percentage.  Make sure you adjust for dividend distributions (if any) to get an accurate view of equity growth rate.

What to look for in equity growth rate

Consistent equity growth of greater than 10% over 5 to 10 years is what a great company should have.  If you see some anomallies in the historical equity growth rates, take the time to understand why those divergences from the trend occurred (both up or down divergences).  Value investing looks for companies with good equity growth rates that may be temporarily under priced.  Comparing the equity growth rate between companies in the same industry is a good way to rate which ones should be considered as an investment.

Technorati Tags: 10 Years, Accurate View, Array, Assets, Balance Sheet Equity, Companion, Dividend Distributions, Earnings, Equity Growth, Excess Profits, Investments, Liabilities, Profitable Businesses, return on equity the same as growth rate, Stock, Surplus Profits, Value Growth Rate, Value Investing, Year 1

Lets look at how to calculate ROIC (Return on Invested Capital).  I make no secret that ROIC is one of my favorite value stock investing tools.   Learning how to calculate ROIC is relatively easy, and will require you to look at a company’s financial reports to get the numbers you need to calculate ROIC.

The formula for how to calculate ROIC is:

ROIC = ((Net Operating Profit – Income Tax) / (long term debt + equity))

 ROIC calculations look like they have a lot going on, but I’ll now show you how easy it is to get everything so you can calculate ROIC.

Lets use Walgreens in 2007 as an example of how to calculate ROIC, click here for the data you’ll need to follow along with this ROIC example.

From the Income statement, the numerator in the ROIC calculation (Net Operating Profit - Taxes) is 2041.3, you can find this about half way down the page.

The next step to learn how to calculate ROIC is to determine the denominator, so we’ll look at the Balance Sheet tab on the above Walgreens data, and find equity is 11,104.3, and long term debt (+ other liabilities) is 1284.8, which means the ROIC denominator is 12389.1.

So ROIC is 2041.3/12389.1 = 15.5%

Now you know how to calculate ROIC.

Technorati Tags: Array, Assets, Balance Sheet, calculating return on invested capital, Capital Return, Cash Investments, Current Liabilities, Debt Equity, Denominator, example roic formula for multiple periods, Excess Cash, Favorite Tools, greenblatt roic, Income Statement, Income Tax, Income Tax Expense, invested capital calculation, Investing Tools, Liabilities, Net Income, Net Term, Numerator, Operating Income, Operating Profit, Profits, Return On Invested Capital, return on invested capital example, roic and other capital efficiency measures, Roic Calculation, Sheet Tab, Stock Investing, Tax Calculations, Tax Rate, Term Debt, Total Net, Value Investing, Value Stock, Walgreens

Value stock investing is an investment strategy that looks for stocks which are undervalued when compared to a value you calculate with various fundamental analysis indicators.  While the description may sound a little complicated, you will see that with a little practice, fundamental analysis for value stock investing is not as difficult as it sounds, in fact, with readily available online tools, finding good value stocks is easy.

First a little history – value stock investing was popularized by Benjamin Graham and David Dodd, and their 1934 book, Security Analysis, remains popular to this day – many bookstores still stock this one on their shelves.  Famous investors like Warren Buffet and Mario Gabelli have made fortunes using the value stock investing strategy to find under priced stocks to buy.

Value stock investors look for stocks with strong fundamental characteristics, such as business revenue growth, cash flow, earnings growth, book value, and cash flow.  All of these items, and more, are found on company’s quarterly and annual reports.  The key is finding stocks that sell at a bargain price vs. their underlying quality based on these fundamental metrics.  Value stock investors constantly seek out companies that are currently incorrectly valued (i.e. undervalued) by the stock market and therefore have the potential to increase in share price when the market corrects its error in valuation.  Some good value stocks pay higher dividend yields due to their lower price relative to the dividend that they pay (there are even monthly dividend stocks that fall inot this category).

Since value stocks are under priced, this means that they are out of favor with the market, which makes value stock investors contrarians by definition.  Buying value stocks can, at times, be tough psychologically, because in many cases, you are buying companies or industries that are receiving a lot of negative press.  Right now there are companies and industries that you can read about in the news, where nearly every article you read in the business press, or every story about them you watch on television, is very negative.  As I write this article in Spring, 2009, there is a recession in full swing, with banks, housing stocks, and REITs all being whacked the most by the business media.  These are the types of areas where value stock investors are prospecting for good companies with good fundamantal characteristics, that are having their stock prices dragged down with the rest of the companies in their industry.  A good tool for determining if a stock is undervalued is to look at it’s earnings yield.

With the tools, resources, and articles posted on this website, value stock investing will become another tool for you to use in your successful online investing activities.

Technorati Tags: Annual Reports, Array, Bargain Price, Benjamin Graham, Bookstores, Business Press, Business Revenue, Cash Flow, David Dodd, Dividend Yields, Earnings Growth, Fortunes, Fundamental Analysis, Fundamental Characteristics, Investing Stock, Investing Strategy, Investment Strategy, Investors, Mario Gabelli, Metrics, Monthly Dividend Stocks, Online Tools, Reces, Security Analysis, Share Price, Shelves, Stock Investing, Stock Investment, Stock Investors, Stock Market, Stock Value, Stocks, Value Investing, Value Investment, Value Stock, Value Stocks, Warren Buffet