Stocks highlighted in this article are: Airvana, Inc. (AIRV), The Buckle, Inc. (BKE), Metavante Technologies, Inc. (MV), Macrovision Solutions, Inc. (MVSN) and Powell Industries, Inc. (POWL).
A stock’s Earnings Yield measures just that, the anticipated yield (or return) an investment in a stock could give you based on the earnings and the price paid for the stock. The calculation is the inverse of the P/E ratio. The P/E, of course, is the Price / Earnings. So a stock trading at a Price of $ 35 with Earnings of $ 3 has a P/E ratio of 11.67, which means it’s selling at 11.67 times earnings. Another way of looking at it is you’re paying $ 11.67 for $ 1 of earnings.
The Earnings Yield is calculated as Earnings / Price. Using the example above, a stock with $ 3 of Earnings trading at a Price of $ 35 ($ 3 / $ 35) has an earnings yield of 0.0857 or 8.57%. The Earnings Yield, also known as the E/P Ratio is expressed as a percentage. So a yield of 8.57% would also mean 8.57 cents of earnings for $ 1 of investment. Of course, this is all potential, because prices and earnings change.
The most common way people will use this ratio is to compare it to other stocks and to compare the yields to the 10 Year T-Bill. Conventional wisdom has it that if the yield on the stock market (S&P 500 for example) is lower than the yield on the 10-Year Treasury (2.89% as of 3/9/09), then stocks might be considered overvalued. If the yield on the S&P 500 is greater than the 10 Year T-Bill, stocks would be considered undervalued.
The theory behind this is that Bonds and Stocks are competing for investors’ dollars. And to attract investment interest in stocks, a higher yield needs to be paid to the stock investor for the extra risk he’s assuming compared to the virtual risk-free investment offered in US-backed Treasuries.
If earnings go up, the yield goes up. If earnings go down, so does the yield. Prices also affect the yield. If Prices go up, the yield goes down. And if prices go down, the yield goes up.
In June of 2007, the Yield on the 10 Yr. T-Bill was 4.95%. However, the Earnings Yield on the S&P 500 was 4.19%. Not much of a risk premium on a risk-based investment.
Remember, if the Earnings Yield on stocks is below the T-Bill rate, stocks are considered overvalued. (I should point out that within months, the market began to falter.)
Currently, the Earnings Yield on the S&P 500 using the 12-Month Projected Earnings Estimate is 9.51%, compared to the 10 Yr. Treasury of 2.89%.
With yields well above the 10 Year, conventional wisdom suggests stocks are in the ‘undervalued’ range. Of course, stocks can continue to get more undervalued. But keeping an eye on this ratio is yet another way to find the right stocks and the right times to get in.
The screen I’m running today looks for the following: * Price >= $ 5 * Volume (Avg. 20 Day Shares) >= 100,000 * Earnings Yield >= 5% (for those using the Research Wizard, the calculation looks like this: (i642/i5)*100. That’s the 12 Month Forward Looking Estimate (i642) divided by the Current Price (i5)) * 12 Month Projected Growth Rate >= 10 * Zacks Rank = 1
Here are 5 stocks from this week’s screen (for Tues. 3/10/09): AIRV Airvana, Inc. BKE The Buckle, Inc. MV Metavante Technologies, Inc. MVSN Macrovision Solutions, Inc. POWL Powell Industries, Inc.
Get the rest of the stocks on this list and start using the Earnings Yield in your own screens.
Kevin Matras is the Research Wizard Product Manager and weekly contributing Editor at Zacks Investment Research who creates and writes the Zacks Commentary Screen of the Week. For more information, visit http://www.zacks.com.