how earnings yield works
money managers often compare the earnings yield of a broad market index such as the s p 500 to prevailing interest rates such as the current 10 year treasury yield if the earnings yield is less than the rate of the 10 year treasury yield stocks may be considered overvalued if the earnings yield is higher stocks may be considered undervalued relative to bonds economic theory suggests that investors in equities should demand an extra risk premium of several percentage points above prevailing risk free rates such as rates on treasury bills in their earnings yield to compensate them for the higher risk of owning stocks over bonds earnings yield as an investment valuation metric is not as widely used as the p e ratio earnings yield can be helpful when there is concern about the rate of return on investment however for equity investors earning periodic investment income may be secondary to growing their investment values over time this is why investors may refer to value based investment metrics such as the p e ratio more often than earnings yield when making stock investments that said the metrics provide the same information just in a different way for investors looking to invest in stocks with stable dividend income earnings yield can offer a direct look into the level of return dividend stocks may generate in this case earnings yield is more of a return metric revealing how much an investment may earn for investors rather than a valuation metric showing how investors value the investment however a valuation metric like the p e ratio can affect a return metric like earnings yield an overvalued investment can lower earnings yield while an undervalued investment can raise earnings yield this is because the higher the stock price goes without a comparable rise in earnings the lower the earnings yield will drop if the stock price falls but earnings stay the same or rise the earnings yield will increase value investors seek the latter scenario the inverse relationship between earnings yield and the p e ratio indicates that the more valuable an investment the lower the earnings yield and the less valuable an investment the higher the earnings yield however investments with strong valuations and high p e ratios might generate lower earnings over time and eventually boost their earnings yield and this is what growth investors look for on the other hand investments with weak valuations and low p e ratios may generate lower earnings over time and in the end drag down their earnings yield example of earnings yieldearnings yield can help investors assess whether or not they want to buy or sell a stock in april of 2019 meta meta formerly facebook was trading near 175 with 12 month earnings of 7 57 which produced an earnings yield of 4 3 this was historically high as the yield had been 2 5 or lower before 2018 between 2016 and 2017 the stock increased by more than 70 while the earnings yield increased from approximately 1 to 2 5 12the stock fell more than 40 off its 2018 high while the earnings yield was near its highest historical level about 3 after the decline the earnings yield continued to creep higher as the price fell reaching over 5 in early 2019 when the stock started to bounce back higher 12the increased earnings yield may have played a role in driving the stock higher mainly because investors expected earnings to improve going forward a high earnings yield relative to prior readings didn t prevent the stock from seeing a significant decline in 2018 12earnings yield may also be helpful in a stock that is older and has more consistent earnings if growth is expected to be low for the foreseeable future the earnings yield can be used to determine when it is a good time to buy the stock in its cycle a higher than typical earnings yield can indicate the stock may be oversold and could be due for a bounce higher assuming no negative news has occurred within the company 