Introduction
Earnings yield refers to the earnings per share in a financial period, divided by the current share price. It is the reciprocal of the P/E ratio. The earnings yield helps investors know how much he has earned per share. If a company has an earnings yield of 8%, it means that the investor has earned Rs.8 for Rs.100 worth of shares owned.
This data is important for investors to compare investments made in different companies, not just in stocks, but also in debentures, fixed deposits, etc. Taking the above example as a reference, an investor can make an investment decision by taking the earnings yield of 8% and compare it against a bond of 6% or a fixed deposit of 7.5%.
Earnings Yield vs P/E Ratio
Formula to calculate earnings yield: Earnings yield = Earnings per share / Market price per share x 100
Formula to calculate P/E ratio: P/E ratio = Market price per share / Earnings per share
The earnings yield is the inverse of the P/E ratio. While the earnings yield tells a shareholder how much he has earned per share held, the P/E ratio tells the investor how long it would take for the company to sustain its earnings to reach the current share price.
The earnings yield also helps the shareholder understand if his shares are yielding him as much as other companies in the same industry. The P/E ratio, on the other hand, determines if the stock is trading at a premium or discount when compared to other companies in the same sector.
Why is the Earnings Yield Useful for Investors?
The earnings yield helps the investors compare and make investment decisions across not just stocks, but other fixed investment options as well. It helps investors know whether their shares are undervalued or overvalued depending on the percentage of the yield when compared to other companies in the same sector.
