When evaluating stocks, many investors are familiar with the price-to-earnings (P/E) ratio – a classic valuation metric. But flip that ratio and you get the sometimes overlooked metric: earnings yield.
In this article, we’ll break down what earnings yield is, why it can be more useful than the P/E ratio in certain contexts, and how you can use it to find potentially undervalued stocks, whether it be using the tools on Validea or other research services.
What Is Earnings Yield?
Earnings yield is a valuation metric that measures how much a company earns relative to its stock price. It is calculated as:
Earnings Yield = Earnings per Share (EPS) / Stock Price
It is essentially the inverse of the P/E ratio:
Earnings Yield = 1 / P/E Ratio
Expressed as a percentage, earnings yield shows what percentage of each dollar invested in the stock is returned to the investor in the form of earnings. For example, a company with an earnings yield of 10% is earning $0.10 for every dollar of share price. Another way to think of it is, if the company paid out all of those earnings as dividends, shareholders would receive an 10% yield on their investment.
Why Use Earnings Yield Instead of the P/E Ratio?
While both metrics provide a view into a company’s valuation, earnings yield offers unique advantages in certain contexts:
- More Comparable to Bond Yields: Unlike the P/E ratio, earnings yield is expressed as a percentage – making it easier to compare a stock’s earnings power to bond yields or other income-generating assets.
- Adjustable for Capital Structure: Some investors use EBIT/Enterprise Value, a version of earnings yield that accounts for debt and cash, to compare companies with different capital structures more accurately.
Joel Greenblatt’s Magic Formula and Earnings Yield
One of the most well-known uses of earnings yield comes from Joel Greenblatt’s Magic Formula investing strategy. In his book The Little Book That Beats the Market, Greenblatt recommends buying stocks with:
- High Earnings Yield (based on EBIT/Enterprise Value)
- High Return on Capital
This two-factor strategy ranks companies based on both profitability and valuation, seeking to uncover businesses that are both good and cheap.
📺 Watch a breakdown of the Magic Formula in this YouTube video overview.
Why Earnings Yield Still Matters Today
In today’s market environment – where interest rates, inflation, and valuation concerns are front and center – earnings yield remains a practical, intuitive metric for investors looking to identify potentially undervalued stocks. It offers a yield-like perspective on a company’s earnings power, making it easier for investors to compare stock valuations to fixed-income investments like bonds. Whether you’re comparing a stock to a 10-year Treasury or building a quantitative strategy, earnings yield offers a straightforward way to assess a company’s earnings power in relation to what investors are paying for the stock.
Further Research on Validea
✅ Predefined High Earnings Yield Screens: Explore stocks that rank highly on earnings yield using our custom screens, updated regularly and based on sound quantitative logic.
✅ Guru Stock Screener: Filter stocks based on earnings yield and other metrics like Return on Capital, momentum, quality, and more. You can even combine factors to create your own version of the Magic Formula.
✅ Joel Greenblatt-Based Model: Our Greenblatt model ranks thousands of stocks based on the original Magic Formula methodology—so you can see which stocks this proven strategy favors right now.
