The Flip Side of the P/E Ratio
Wednesday, February 25th, 2009In 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