Earnings Yield

RECENT NEWS
The Economic Times  May 19  Comment 
There is scope for further gains if Nifty's earnings yield is compared with 10-yr bond yield.
Disciplined Approach to Investing  May 26  Comment 
Standard & Poor's notes in a recent report on Earnings Yield By Sector that seven of ten S&P 500 sectors have earnings yields greater than their long term averages. As of mid-May, the S&P report notes, "the earnings yield on the S&P 500 was 5.4%...




 
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Earnings yield is the inverse of the price-earnings ratio (p/e ratio). It measures the amount of profit a company has generated compared to its market capitalization. E.g. if a company with a market value of $ 500 million has generated $ 50 in net profits in a particular year, then it has generated a 10% yield. A 10% yield is equal to a p/e ratio of 10, which means that if earnings will constant coming years, then it takes 10 years to earn your investment back.

As an investor, you want to have an earnings yield that is as high as possible, since the company generates earnings that are higher compared to its market capitalization. The efficient market school will disagree with you, since they adhere to the explanation that lower p/e ratios are due to higher risk associated with the stock. The school of Behavorial Finance, but also value investors, will explain the fact that investors that have been negative about the stock, have been extrapolating these negative forecasts in the future, while in fact earnings and prospects might revert back to the mean.

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