Chicago, IL – March 16, 2010- Kevin Matras talks about a stock’s Earnings Yield and how to use it. Stocks in this week’s article include Carlisle Companies Inc. (NYSE: CSL), Cisco Systems, Inc. (NASDAQ: CSCO), Molex Inc. (NASDAQ: MOLX), Signet Jewelers Ltd. (NYSE: SIG) and Whirlpool Corp. (NYSE: WHR).
Screen of the Week written by Kevin Matras of Zacks Investment Research:
A stock’s Earnings Yield measures just that: the anticipated yield (or return) an investment in a stock could give you based on the earnings and the price paid for the stock.
The Earnings Yield is calculated as Earnings / Price
A stock with $3 of Earnings trading at a Price of $35 ($3 / $35) has an earnings yield of 0.0857 or 8.57%. The Earnings Yield, also known as the E/P Ratio, is expressed as a percentage. So a yield of 8.57% would also mean 8.57 cents of earnings for $1 of investment. Of course, this is all potential because prices and earnings change.
The most common way people will use this ratio is to compare it to other stocks and to compare the yields to the 10 Year T-Bill.
Conventional wisdom has it that if the yield on the stock market (S&P 500 for example) is lower than the yield on the 10 Year Treasury (3.71% as of 3/15/10), then stocks might be considered overvalued. If the yield on the S&P 500 is greater than the 10 Year T-Bill, stocks would be considered undervalued.
The theory behind this is that Bonds and Stocks are competing for investors’ dollars. And to attract investment interest in stocks, a higher yield needs to be paid to the stock investor for the extra risk he’s assuming compared to the virtual risk-free investment offered in US backed Treasuries.
If earnings go up, the yield goes up. If earnings go down, so does the yield. Prices also affect the yield. If Prices go up, the yield goes down. And if prices go down, the yield goes up.
I wrote about this in March of 2009. At that time, the Earnings Yield on the S&P 500 using the 12 Month Projected Earnings Estimate was 9.51%, compared to the 10 Yr. Treasury of 2.89%. With yields well above the 10 Year, conventional wisdom said that stocks were ‘undervalued’. Of course, they could have continued to get more undervalued. But the market was quickly bid up – resulting in one of the largest rallies we’ve ever seen.
Currently, the Earnings Yield for the S&P is 7.01%, compared to the 10 Yr. Treasury of 3.71%. So the market isn’t as much of a bargain as it was back in March of ’09. But it’s still way better than the 10 year and suggests that stocks are still the more attractive investment.
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