Earnings Yield

The earnings yield (aka earnings-price ratio, E/P ratio) for stocks is the inverse of the price-earnings ratio (P/E) of stocks, equal to the earnings per share of common stock divided by its market price. The E/P ratio increases with earnings and decreases with increases in the stock price.

Traders sometimes compare the earnings yield of stocks to bonds, money market instruments, or Treasuries. Since stocks are riskier, earnings yields are usually higher than Treasury yields; the difference is the equity risk premium, the amount earnings yields should exceed Treasury yields to justify the risk of holding stocks. One rule of thumb, based on how the earnings yield of the S&P 500 stocks and the yield on 10-year Treasury bonds have correlated over the past few decades, is that if the earnings yields on stocks are less than 10-year Treasuries, then the stock market as a whole is overvalued since higher stock prices will lower the earnings yield. Earnings yields should be higher since stocks are much riskier than Treasuries. However, many argue that a better indicator of future stock performance only depends on the earnings yield itself rather than its difference from 10-year Treasury yields since a low earnings yield means that stock prices are relatively expensive.

For instance, in June 2007, the 10-year Treasury note yielded 4.95%, while stocks in the S&P 500 averaged 4.19%, thus indicating that stocks were overvalued. Subsequently, stocks declined dramatically over the next year and a half. In March 2009, the 10-year Treasury yielded 2.89% while the S&P yielded 9.51%. Over the next 5 years, the S&P 500 index more than doubled! In January 2025, the S&P earnings yield was about 3.2% while 10-year Treasuries were yielding 4.2%.

Earnings Yield and Return on Equity

The earnings yield is also related to the return on equity (ROE), 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

Note that the stock price in both the numerator and denominator of the 2^nd equation cancel each other, equaling the right-hand side of the 1^st equation, proving that the 2 equations are equal. Solving for E/P in the 2^nd equation by dividing both sides by P/B yields: