- Privacy Policy For thismatter.com
- Information is provided 'as is' and solely for education, not for trading purposes or professional advice.
- Copyright © 2005 - 2011 by William C. Spaulding
The earnings yield (aka earnings-price ratio, E/P ratio) for stocks is the inverse of the price-earnings ratio (P/E) of stocks, and is equal to the earnings per share of common stock divided by the market price of the stock.
Earnings Yield = Earnings per Share of Common Stock / Stock Price
Traders sometimes compare the earnings yield of stocks to bonds, money market instruments, or Treasuries. One rule of thumb, based on how closely the earnings yield of the S&P 500 stocks and the yield on 10-year Treasury bonds have tracked each other over the past few decades, is that if the earnings yields on stocks is less than 10-year Treasuries, then the stock market as a whole is undervalued.
If a stock has a P/E ratio of 20, then what is its earnings yield?
Earnings Yield = 1 / P/E = 1 / 20 = 0.05 = 5%
The earnings yield is also related to the return on equity, which is simply the earnings per book value, and can be found by multiplying the earnings yield (E/P) by the price/book value (P/B).
ROE = Earnings / Book Value
| ROE = | E ─ P | X | P ─ B | = | E ─ B |
Note that the stock price in both numerator and denominator of the 2nd equation cancel each other, equaling the right-hand side of the 1st equation, thereby proving that the 2 equations are equal. Solving for E/P in the 2nd equation by dividing both sides by P/B yields:
| E ─ P | = | ROE ──── P/B | E = Earnings P = Stock Price B = Book Value |