Here's a measure few people know about that can shed some light on your investing process: the earnings yield. It's actually the inverse of the price-to-earnings (P/E) ratio. The P/E is a stock's current price divided by its earnings per share (EPS) over the past or upcoming year. To get the earnings yield, you just flip those, dividing EPS by the stock price.
Here -- check out some examples, all of which have earned 4- or 5-star ratings (out of five) from our Motley Fool CAPS community:
Company
Recent Stock Price
Trailing 12-Month EPS
P/E Ratio
Earnings Yield
Agrium (NYSE: AGU)
$37.14
$6.73
5.5
18.1%
Cardinal Health (NYSE: CAH)
$29.89
$3.32
9.0
11.1%
Viacom (NYSE: VIA-B)
$20.99
$1.88
11.2
9%
3M (NYSE: MMM)
$60.63
$4.26
14.2
7%
PepsiCo (NYSE: PEP)
$56.09
$3.23
17.4
5.8%
Novo Nordisk (NYSE: NVO)
$54.20
$3.09
17.5
5.7%
Allergan (NYSE: AGN)
$45.96
$1.69
27.2
3.7%
Data: Yahoo! Finance, Motley Fool CAPS.
It's nice to have an idea of what you can expect from a stock. A dividend yield gives you one idea (a 3% yield means you can expect to receive 3% of your investment each year), but not all companies pay dividends, and dividends sometimes shrink.
What it means
The earnings yield connects a company's financial results to the current price of its shares. You can think of it as an indicator of the return on your investment in a company's stock, even though you don't get actual cash as you would with dividends. Not surprisingly, low-P/E stocks produce high earnings yields, and vice versa.
But be careful when you compare earnings yields to returns on other types of assets. For instance, look what happens if you compare a company's earnings yield to returns on bonds. These days, 10- and 30-year Treasury bonds are yielding between about 3.5% and 4.5%. Given that, Allergan, above, doesn't seem like such a bargain, with its 3.7% earnings yield.
But bear in mind that while a bond offers only a given return on a fixed investment, earnings in strong companies should grow over time. Even if a company's earnings yield stays constant, its stock price can go up as earnings rise. If a company's earnings rise fast enough, then even a low current earnings yield may look attractive over the long haul.
The earnings yield is just one more way to look at a company. It can be a helpful factor in evaluating and comparing stocks.
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