Lets talk a little about the value measurement of earnings yield.
While this measurement is being more widely followed, it remains a very key tool is
obtaining the true value of a security.
The earnings yield is nothing more that the opposite or reciprocal of the P/E ratio.
It helps to put value in a more easily understandable light as it can be measured against
the prevailing 10 year note yield.
The premise is that if the earnings yield on the market or whatever stock you wish to measure is greater than the 10 year note yield then the security is undervalued. Now this is a gross simplification of the theory, but it gives you a reference point.
Don't forget also that the 10 year T- note yield is a before tax measurement and the earnings yield is an after tax measurement. Therefore even if the earnings yield is less that the 10 year note yield, there is still a possability of a security being undervalued.
This gives you a very strong starting point as to where to go from here with the tool. Especially the after tax aspect of the earnings yield.
Here is an example of the calculation for the earnings yield on a stock.
Let us suppose a stock has a P/E ratio of 12. In order to get the earnings yield we just invert the 12/1 fraction to 1/12 and the yield comes to 8.33%. Compare this to the 4.5% 10 year note yield and you have quite the undervalued security. Maybe even more so than the 8.33% dictates as this is the after tax yield. To convert it to the before tax yield simply multiply the 8.33% by 1.33 for the 33% corporate tax bracket. The before tax yield becomes 11.08% which makes this security very undervalued.
While this measurement is being more widely followed, it remains a very key tool is
obtaining the true value of a security.
The earnings yield is nothing more that the opposite or reciprocal of the P/E ratio.
It helps to put value in a more easily understandable light as it can be measured against
the prevailing 10 year note yield.
The premise is that if the earnings yield on the market or whatever stock you wish to measure is greater than the 10 year note yield then the security is undervalued. Now this is a gross simplification of the theory, but it gives you a reference point.
Don't forget also that the 10 year T- note yield is a before tax measurement and the earnings yield is an after tax measurement. Therefore even if the earnings yield is less that the 10 year note yield, there is still a possability of a security being undervalued.
This gives you a very strong starting point as to where to go from here with the tool. Especially the after tax aspect of the earnings yield.
Here is an example of the calculation for the earnings yield on a stock.
Let us suppose a stock has a P/E ratio of 12. In order to get the earnings yield we just invert the 12/1 fraction to 1/12 and the yield comes to 8.33%. Compare this to the 4.5% 10 year note yield and you have quite the undervalued security. Maybe even more so than the 8.33% dictates as this is the after tax yield. To convert it to the before tax yield simply multiply the 8.33% by 1.33 for the 33% corporate tax bracket. The before tax yield becomes 11.08% which makes this security very undervalued.
You can also use the earnings yield of an entire index such as the S&P 500 to get a feel for the current state of value in the market. Above this post you will see a visual of the current earnings yield model that shows the S&P 500 to be quite undervalued. This does not take into account the after tax effect which would move the target for the S&P 500 even higher.
The earnings yield is a great tool and should be in every good investors toolbox.
