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What Is An Earnings Yield?

The Motley FoolThe earnings yield is closely related to the P/E ratio. In fact it is the inverse of the P/E ratio expressed as a percentage.

The P/E ratio is the relationship between the price (or value) of a business compared to its profit. So a P/E of 8 means that an investor is prepared to pay $8 for every dollar of profit that a company makes.

The inverse of that, in other words the E/P, is the earnings you expect for every dollar of investment in the company, So, a P/E of 8 would translate to an earnings yield of (1/8*100) or 12.5%. It is the return you would expect if all the earnings are paid out to you. It can be useful when looking at companies that do not pay dividends.

The earnings yield is also particularly useful when comparing the broad market with prevailing interest rates. By and large, investors demand a higher return when investing in the stock market because of the inherent risk compared to, say, government bonds.

Consequently, if the earnings yield is lower than, say, 10-year bond yields, then you could say the stock market may be overvalued. But if the earnings yield is significantly higher than the bond yields, then you might consider the stock market to be largely undervalued.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.