Earnings Yield vs P/E Ratio

The earnings yield of a stock is a measure of its earnings per share for the past year divided by the current market price of a share. It is essentially the exact opposite of a price to earnings (P/E) ratio. A P/E ratio is used to measure the relative value of a stock by asking the question: what do I get for my money? With earnings yield, the measurement is a greater reflection of the stock's performance, as compared to other companies, the market as a whole and, less-risky investment options.

Earnings Yield vs P/E Ratio

With earnings yield, you are measuring how much money the average investor who purchased a specific stock earned in a given year for their purchase. P/E is more commonly used to measure a specific investor's profit in a trade or purchase. For example, if you purchased 10 shares of Company A for $15 per share and received $40 in dividends, your P/E was 150/40 or 3.75. If you hold the shares another year and receive another $60 in dividends, your P/E would be 150/100 or 1.5. Finally, in the third year, you receive $70 in dividends. Your P/E at that point would be 150/70 or 2.14, finally pushing you into profits. This is a great way to measure how much you have individually earned, but the experience of another investor who purchased at a different time would be different from your P/E.

This is where earnings yield may be a better measure. At any given point, the earnings yield of a stock can be calculated by measuring the last 12 months of earnings per share (EPS) and dividing it by the current price of a share. Instantly, an analyst can know the average earnings of an investor in the stock for the past year.

Comparing Earnings Yield of Two Stocks

Earnings yield can be used to show which of two stocks is a more favorable purchase at any given time. Regardless of when you will purchase the stock and how long you will hold it, you can estimate what the relative earnings will be on the stock based on its performance over the last year. If Company A had a better earnings yield than Company B this year, and all factors remain equal, Company A will be the better investment in the years to come. 

Comparing Earnings Yield to Bond Yield

Earnings yield is more commonly used as an indicator of the health of the stock market than as a measure of which stocks to purchase. The earnings yield of an entire index, like the S&P 500, is often compared to a base point like the current 10-year Treasury bond rate. As a rule, if the earnings yield is lower than the bond yield in a period of time, stocks have been overvalued. The inverse is true if the earnings yield is higher than the bond yield. On a particular stock, you should aim to see the earnings yield at least a few percentage points higher than a bond's yield. You will want to be rewarded for the increased risk you have taken on.

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