Earning Yield

Earning yield is a financial metric used to evaluate the profitability of a company relative to its market price. It is the inverse of the Price-to-Earnings (P/E) ratio and is calculated by taking the earnings per share (EPS) and dividing it by the share price. The formula for earning yield is:

Alternatively, it can also be calculated using EBIT (Earnings Before Interest and Taxes) or EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and dividing it by the enterprise value of the company. These versions are often used when comparing the earning yield of an entire market or when comparing companies with different capital structures.

Importance in Investment and Trading

The earning yield is often used by investors to compare the potential profitability of investing in a stock versus other investment opportunities, such as bonds or real estate. A higher earning yield generally suggests that an investment is more attractive, assuming the risk profile and other investment criteria are similar.

Earning yield can also be compared to interest rates to determine whether equities seem overvalued or undervalued. For example, if the earning yield of a stock is higher than the yield on a 10-year Treasury bond, some investors might consider the stock to be undervalued, making it an attractive investment opportunity.

Limitations

Like any financial metric, earning yield has limitations. It doesn’t account for future growth prospects, the quality of management, or other qualitative factors that could affect a company’s performance. Additionally, different industries tend to have different average earning yields, so it’s often most useful when comparing companies within the same sector.

In your role as a financial analyst in an asset management company, the concept of earning yield could be a useful tool for quickly assessing the relative value of different investment opportunities. It can serve as an initial filter in the asset selection process, helping to identify potentially undervalued or overvalued assets.

REFERENCES

OpenAI. (2023). ChatGPT (September 25 Version) [Large language model]. https://chat.openai.com