Earnings Yield

Earnings yield is the ratio of earnings per share to current stock price. It measures dollars earned per $100 dollars invested in a company at current stock price. Earnings yield is the reciprocal of the price to earnings (P/E) ratio and it is expressed as a percentage.

Earnings per share equals net income attributable to common stock-holders divided by weighted average number of shares of common stock. Net income attributable to common stock-holders equals net income minus preferred dividends. The earnings yield can be calculated based on last year’s earnings per share in which case it is the trailing earnings yield. Alternatively, it can also be calculated based on earnings expected over the next year in which case it is the forward earnings yield.

Earnings yield is useful in comparing return on a stock with return on other asset classes. Other similar concepts include cash flow yield, dividends yield, capital gains yield, etc.

Formula

The following formulas can be used to work out earnings yield:

$$ Earnings\ Yield=\frac{EPS}{P_0} $$

$$ Earnings\ Yield=\frac{1}{P/E\ ratio} $$

The inverse of the trailing P/E ratio is the trailing earnings yield and the inverse of the forward P/E is the forward earnings yield.

Example

A company’s net income is $20 million out of which $4 million must be paid as dividend on preferred stock. Number of shares at the start of the year were 10 million and 2 million additional shares were issued mid-year. Calculate the (trailing) earnings yield if the current stock price is $25 per share.

First, we need to work out the EPS. The numerator of the EPS equals net income available to common stock-holders which equals net income minus preferred dividends. Second, we need to work out weighted average number of shares.

$$ EPS=\frac{$20\ million\ -\ $4\ million}{10\ million\times\frac{12}{12}+2\ million\times\frac{6}{12}}=\frac{$16\ million}{11\ million}=$1.45 $$

Earnings yield equals EPS divided by current stock price:

$$ Earnings\ Yield=\frac{$1.45}{$25}=5.81\% $$

The earnings yield can be compared with yield on bonds or return on other assets classes such as real estate, etc.

Earnings yield can be converted to P/E ratio using the following equation:

$$ P/E\ ratio=\frac{1}{Earning\ Yield}=\frac{1}{5.81\%}=17.18 $$

Written by Obaidullah Jan, ACA, CFA and last modified on