Earnings Yield as an Investment Value Tool
Earnings yield is the annual earnings of a stock, individual company, or market index compared to its price. In other words it is earnings divided by price. It is expressed as a percentage of the investment value and is the reciprocal of the price/earnings (P/E) ratio.
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Examples of the Earnings to Price Yield Calculation (Jan 2015)
Earnings to Price Yield of a Stock
Chevron (CVX) earned $10.86 and the price is $108.
Earnings Yield = $10.86 / $108 = 10%
Earnings to Price Yield of a Company
Chevron (CVX) earned $20.7 billion and has a Market Capitalization of $205 billion.
Earnings Yield = $11 billion / 106 billion = 10%
Earnings to Price Yield of an Index
The S&P 500 has earnings of $88 with the index at $1486.
Earnings Yield = $103 / 2045 = 5%
Greenblatt’s Magic Formula Value Approach to Earnings Yield
Magic Formula Earnings Yield is a popular valuation tool for value investors. In “The Little Book that Beats the Market” by Joel Greenblatt; he provides a little different calculation that many analysts use as part of his “Magic Formula”.
Magic Formula Earnings Yield = Operating Earnings / Enterprise value
I like using enterprise value because it is a more accurate metric of the total investment value of a company. This is because it makes allowances for debt and cash.
Operating earnings, also known as earnings before interest and taxes (EBIT), are the earnings produced by the ongoing operations of the entity. This removes the distortions caused by extraordinary write downs, the effects of financing and taxes.
Intel has Operating Earnings of 17 billion and an enterprise value of 101 billion.
Magic Formula Earnings Yield = 17 billion / 101 billion = 17%
Importance of the Earnings to Price Yield
There is currently a great deal of emphasis put on dividends and dividend yield. But where do these dividends come from? Earnings of course. Earnings are the true long term driver of dividends and stock price.
You may have a stock that has a high dividend yield but pays out all of its earnings. This company may not have the capital to grow earnings or even sustain the high dividend. Earnings are the most important metric in analyzing individual investments.
All of the above methods of calculating earnings to price yield provide a means to compare stocks, companies, indexes, etc. But this is also a valuable metric for comparing to other assets. For instance, you can compare the S&P500 earnings to price yield to the 10 year Treasury Bond yield, or to the current inflation rate.
Use the earnings to price yield as a value tool because it’s simple and provides critical information that can be compared to any other investment asset.
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While Arbor Investment Planner has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability, or completeness of third-party information presented herein. The sole purpose of this analysis is information. Nothing presented herein is, or is intended to constitute investment advice. Consult your financial advisor before making investment decisions.