Legal Definitions - earnings yield

The earnings yield is a financial metric that expresses a company's earnings per share (EPS) as a percentage of its current stock price. Essentially, it tells an investor how much the company has earned over the past year for every dollar invested in its stock. It is the inverse of the more commonly known price-to-earnings (P/E) ratio. A higher earnings yield generally indicates that a stock might be more attractive because it suggests the company is generating more earnings relative to its share price, potentially offering a better return on investment compared to other options like bonds.

Here are some examples to illustrate the concept:

• Comparing Investment Opportunities: Imagine an investor, Sarah, is evaluating two different companies for her portfolio. Company A has a stock price of $100 and reported earnings per share of $8. Company B has a stock price of $50 and reported earnings per share of $3. To calculate the earnings yield for Company A, she divides $8 by $100, resulting in an 8% earnings yield. For Company B, she divides $3 by $50, yielding a 6% earnings yield. Based solely on this metric, Company A appears to be generating more earnings relative to its stock price, suggesting it might be a more efficient earner per dollar invested compared to Company B.

• Stock vs. Bond Comparison: A financial analyst is advising a client on whether to invest in the stock market or in government bonds. The analyst calculates that the average earnings yield for a basket of large-cap stocks is currently 5.5%. Simultaneously, a U.S. Treasury bond is offering a yield of 4%. By comparing these figures, the analyst can explain that for every dollar invested, the stock market, on average, is currently generating 5.5 cents in earnings, while the bond offers a guaranteed 4 cents in interest. This comparison helps the client understand the relative attractiveness and potential risk-reward of equity investments versus fixed-income securities.

• Market Valuation Assessment: A market strategist is assessing whether the overall stock market is currently overvalued or undervalued. They observe that the average earnings yield for the entire S&P 500 index is currently 4.8%. Historically, during periods considered to be "cheap" markets, the average earnings yield was closer to 7%, while during "expensive" periods, it dipped below 3%. By comparing the current 4.8% earnings yield to historical averages, the strategist can infer that the market is neither extremely cheap nor extremely expensive based on its earnings generation relative to stock prices, providing insight into the broader market's valuation.