Definition
Earnings yield is a financial ratio that indicates the level of annual earnings relative to the price of a stock or investment. It is calculated by taking the earnings per share (EPS) for the most recent 12-month period and dividing it by the current market price per share. The result is often displayed as a percentage, and a higher earnings yield generally implies a more undervalued or profitable the investment.
Key Takeaways
- Earnings Yield is a financial solvency indicator which demonstrates the percentage of each dollar invested in a stock that was earned by the company. It is essentially the inverse of the P/E ratio.
- It is a significant tool for comparing the relative attractiveness of different investments. A higher Earnings Yield signifies a potentially undervalued company – offering more profit per dollar invested.
- A common way to use the Earnings Yield is in comparison to interest rates, such as those on government bonds. When the earnings yield of a stock is higher than the rate of a risk-free government bond, it could suggest that the stock is undervalued and a better investment option.
Importance
Earnings Yield is a vital financial metric as it provides investors a benchmark to compare the profitability and risks of different investments. It is a tool that gauges a company’s profitability by showing how much earnings a firm has generated in comparison to the price of its stocks.
This comparison can dictate a company’s appeal to the investors, showing whether investments will be potentially rewarding. An increase in earnings yield could indicate a good investment opportunity as it typically means the business is profitable and can potentially provide higher returns.
It also provides an understanding, if the company is over-valued or under-valued, thereby, helping investors make informed decisions. Therefore, Earnings Yield is crucial in analyzing the financial health of a business and its appeal to investors.
Explanation
Earnings Yield, a crucial concept in financial analysis and investing, serves as an indicator that determines the profitability or earning capacity of a company or a particular stock in the market. It is a financial ratio that shows the earnings per share for the most recent 12-month period divided by the current market price per share, communicating to investors and analysts how much a company makes against its share price.
Providing this measure moves beyond merely providing a snapshot of a company’s profitability; it affords a benchmark for comparing prospective investments or assessing market conditions. Most importantly, the earnings yield is widely used to compare the projected earnings of investing in a specific stock versus investing that same capital in a safer option like treasury bonds or another relatively risk-free asset.
In essence, it assists investors in gauging the risk and rewards of different investment options. This tool is particularly useful in assessing the valuation of a company, ie., whether it is overvalued or undervalued, and in making informed decisions about the timing of investment.
When the earnings yield of a company is high, it could indicate that the shares of the company are undervalued, suggesting a potential investment opportunity.
Examples of Earnings Yield
Earnings yield, expressed as a percentage, is a financial term that shows the earnings generated and realized on an investment relative to the price of the investment. It’s essentially the inverse of the Price to Earnings (P/E) ratio, where Earnings Yield = Earnings per Share (EPS) / Share Price. Here are three real world examples to illustrate this concept:**Apple Inc. (AAPL)**: As of the end of 2021, Apple Inc. reported an Earnings per Share (EPS) of $If the current market price (as of the last trading day of 2021) is approximately $43, then the earnings yield would be calculated as: $61/$43 =0314 or14%. This suggests that for every dollar invested in Apple, the company generates about
14 cents in earnings.**Amazon Inc. (AMZN)**: As of the end of 2021, Amazon reported an EPS of $If the current market price is $3,39, the earnings yield would be: $56/$39 =0154 or54%. This suggests that for every dollar invested in Amazon, the company generates about
54 cents in earnings.**Microsoft Corp. (MSFT)**: As of the end of 2021, Microsoft Corp. reported an EPS of $If the current market price is $87, the earnings yield would be: $05/$87 =0241 or41%. This suggests that for every dollar invested in Microsoft, the company generates about
41 cents in earnings.These examples demonstrate that companies with higher earnings yield can potentially provide better returns for investors, but it also depends on other factors like growth potential and risks associated with the business.
Earnings Yield FAQ
What is Earnings Yield?
Earnings yield refers to the earnings per share for the most recent 12-month period divided by the current market price per share. The earnings yield (which is the inverse of the P/E ratio) shows the percentage of a company’s earnings per share. It’s a way to measure the return on investment for a stock.
How is Earnings Yield calculated?
Earnings Yield is calculated by taking the earnings per share (EPS) and dividing it by the current market price of a share. With this result, we obtain a percentage that represents the company’s earnings yield.
Why is Earnings Yield important?
Earnings yield is important as it is used by investors to compare the profitability of different companies before making investment decisions. A higher earnings yield means a company is more profitable, which might mean a better investment opportunity.
How does Earnings Yield differ from P/E ratio?
Earnings Yield is the inverse of Price to Earnings (P/E) ratio. While P/E ratio shows how much you would have to spend to make one dollar of company’s earnings, Earnings Yield shows how much earnings a company produces relative to its share price.
What does a high Earnings Yield indicate?
A high Earnings Yield could potentially indicate that a company’s stock is undervalued, or that the company is operating efficiently. However, it’s important for investors to consider other financial indicators and market factors as well before making a decision.
Related Entrepreneurship Terms
- Price to Earnings Ratio (P/E Ratio)
- Dividend Yield
- Stocks Valuation
- Return on Investment (ROI)
- Earnings per Share (EPS)
Sources for More Information
- Investopedia: A comprehensive resource for investing and personal finance education, including the Earnings Yield.
- CNBC: A leading source of financial news and market updates, offering articles that often analyze the concept of Earnings Yield.
- MarketWatch: Another great source for financial information, news and insights, including details about Earnings Yield.
- Morningstar: A platform which offers detailed financial data on all matters finance, including Earnings Yield.
