In the last couple of posts we discussed some of the basics of the PE ratio. However, an often more meaningful measurement is obtained by, literally, flipping the P/E ratio upside down.
Earnings Yield
While the P/E ratio helps us understand the price of a stock relative to its earnings, the earnings yield gives us more of a “yield” or percentage return metric. Let’s use our prior example of Friend A from our PE ratio explained part II post.
Friend A’s company has earnings of $5 per share, and he is selling shares to investors for $10 per share. Let’s say he realizes that, given the prospects for growing his business, $10 per share is way too cheap to be offering shares. So, he starts selling shares for $100 per share. His earnings yield is simply the result of dividing Earnings Per Share by Price Per Share and expressing as a percentage:
Earnings Yield ( % ) = ($5 per share / $100 per share) X 100 = 5%
We’ll see in our next post that this metric is particularly useful for comparing different types of investments.
Tags: earnings yield, pe ratio, Stock Metrics