Earnings Yield

Earnings Yield Definition

Earnings Yield helps the investor understand how much he will be earning for each dollar invested in the company and is therefore calculated as Earnings per share are divided by the stock price per share. This ratio helps an investor to make the comparison between two or more companies or between investment in shares versus the investment in risk-free security i.e. the company which has a higher yield will be a better performer as it provides higher earning for each dollar invested.

Earnings Yield Formulas

Below are the two formulas –

Earnings Yield Formula = Earnings Per Share / Stock Price Per Share*100

Here we take the 12 months earnings per share of the company is divided by the market price per share of the stock and represent in a percent manner to make the comparison.

Earnings Yield  Formula=1/Price Earning * 100

As we know that it is the inverse of P/E P/EThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. read more, we can calculate it by using the above formula and represent it in a percent manner to make the comparison.

Earnings Yield Formula

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For eg:
Source: Earnings Yield (wallstreetmojo.com)

How is Earnings Yield used by Investors?

Consider an investment in stock as against an investment in a Treasury bill or a fixed deposit, which are virtually risk-free investments. So, if the earnings yield of an investment in the stock is higher than the treasury billTreasury BillTreasury Bills or a T-Bill controls temporary liquidity fluctuations. The Central Bank is responsible for issuing the same on behalf of the government. It is given at its redemption price and a discounted rate and is repaid when it reaches maturity.read more / Fixed deposit, only then will it make sense to invest in stock as we take risks while investing in stocks.

The Earnings yield of 10 years treasury bill is 4.5%, i.e., we earn 4.5% for each dollar invested, and the yield for the stock of Company A INC is 8.28 %, i.e., we earn 8.28% for each dollar invested. This clearly shows that the additional risk which we are taking by investing in stock instead of the treasury bill is providing additional returns. If the yield of the risk-free security is equal to or more than the stock, we can say that the stock is overvalued stocksOvervalued StocksOvervalued Stocks refer to stocks having more current market value than their real earning potential or the P/E Ratio. Overvaluation of stocks might occur due to illogical decision making or deterioration in a Company’s financial health. read more. As we can clearly see in such a case, there are no additional benefits received by making a riskier investment.

Examples

Now, let us understand the concept with the help of some simple and practical examples.

You can download this Earnings Yield Excel Template here – Earnings Yield Excel Template

Example #1

Following is the information provided to us for company A INC and Company B INC.

ParticularsCompany ACompany B
Earnings Per Share1525
Market Price Per Share120140

Solution

The calculation for Company A

Earnings Yield Example 1.1
  • =15/120*100%
  • =12.50%

The calculation for Company B

Example 1.2
  • =25/140*100%
  • =17.86%

Here as we can see that the earnings yield of company B is higher than company A, i.e., for each dollar invested in company B, we will earn 17.86% as compared to only 12.50% in company A. So, we conclude that investment in Company B is better.

Example #2

We are given that the stock Mr. A has an investment to be made, and he is having 2 options of the same he is providing us with the following details.

  • BDO Bank is currently trading at $ 1340 per share, and it’s earning per share is $ 50.
  • CFDH Bank is currently trading at $ 1250 per share, and its earnings per share is $ 41, which of these banks he should select to maximize his earnings.
ParticularsBDO BankCFDH Bank
Earning Per Share5041
Market Price Per Share1,3401,250

Solution

The calculation for BDO Bank

Earnings Yield Example 2.1
  • =50/1340*100%
  • = 3.73%

The calculation for CFDH Bank

Example 2.2
  • =41/1250*100%
  • = 3.28%

After calculating it, we can understand that BDO bank is earning 3.73% for each dollar invested and CFDH Bank is earning 3.28% for each dollar invested. Therefore, it is clear that to maximize the returns, Mr. A should invest in BDO Bank.

Difference Between Earnings Yield and Dividend Yield

Below are certain differences between Earning and Dividend YieldDividend YieldDividend yield ratio is the ratio of a company's current dividend to its current share price.  It represents the potential return on investment for a given stock.read more.

Importance

Conclusion

After understanding the concept, we can come to a conclusion that it helps the stakeholders to understand about the return for each dollar invested and also to make sure that the additional risk of investing in stock over risk-free security (like treasury bill, gold, fixed deposit) is worth taking or not.

Recommended Articles

This article has been a guide to Earnings Yield and its definition. Here we discuss the formula for calculation of earnings yield along with examples and its differences from dividend yield. You can learn more about accounting from the following articles-

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