Earnings Yield Definition: Earnings yield is a company’s earnings per share divided by its share price, expressed as a percentage. It is the inverse of the P/E ratio, so a stock trading at 20 times earnings has an earnings yield of 5%. Investors use it to compare what stocks earn with the interest paid by bonds and cash.
What Is Earnings Yield?
Turn the P/E ratio upside down and you get a number that looks like an interest rate. A P/E of 25 tells you investors pay $25 for each dollar of annual profit. The earnings yield tells you the same thing the other way round: each $100 invested buys $4 of profit a year.
That framing makes stocks comparable with everything else that pays a yield. A savings account, a government bond and a share all compete for the same money. Earnings yield lets you line them up on one scale, which is how many investors think about the question of whether stocks are cheap or expensive.
Still, the comparison is rough. Bond interest arrives in cash, while a company keeps much of its profit and decides what to do with it. The next sections show how to calculate the yield and where that difference starts to matter.
How to Calculate Earnings Yield
The formula is earnings yield = earnings per share ÷ share price × 100. You can use trailing earnings from the last 12 months or forecast earnings for the next year, and the result changes with that choice. At the market level, the same calculation uses total index earnings divided by the index level.
Suppose a stock trades at $80 and earned $4 per share over the past year. Its earnings yield is 4 ÷ 80 = 5%. If 10-year Treasury bonds yield 3%, the stock offers two percentage points more, a gap investors call the equity risk premium.
Now let the bond yield rise to 6% while the stock stays at $80. The stock’s 5% now looks thin against a safe 6%, so some investors sell shares and buy bonds. If the price falls to $60, the earnings yield climbs to 6.7%, restoring a premium over bonds. This is the mechanism behind the idea that rising rates pull stock valuations down.
Earnings Yield vs. Bond Yield
Comparing the stock market’s earnings yield with the 10-year Treasury yield became known as the Fed model, after a 1997 Federal Reserve report showed the two moving together. Strategist Ed Yardeni gave it the name. The model says stocks are cheap when their earnings yield is above the bond yield and expensive when it is below.
History offers two clear extremes. At the start of 2000, the S&P 500 traded near 30 times trailing earnings, an earnings yield of about 3%, while 10-year Treasuries paid more than 6%. In mid-2012 the picture was reversed: the index’s earnings yield was around 7%, and the 10-year yield had fallen below 2%. Stocks fell sharply after the first moment and rose for years after the second.
| Earnings Yield | Bond Yield | |
|---|---|---|
| What it measures | Company profit per dollar of share price | Interest per dollar of bond price |
| Paid in cash | Only the part paid as a dividend | Yes, as coupons |
| Grows with inflation | Earnings often rise with prices | Coupons are fixed in nominal terms |
| Certainty | Earnings can fall or vanish | Fixed unless the issuer defaults |
Why Is Earnings Yield Important for Traders?
Earnings yield is the simplest link between interest rates and stock prices. When central banks push yields up, the premium stocks offer over bonds shrinks, and investors demand lower prices to restore it. That is why equity markets often react sharply to bond market moves even when company profits have not changed.
Its main flaw is that it compares a real return with a nominal one. Bond coupons are fixed, while company earnings tend to rise with inflation. Cliff Asness made this point in a 2003 paper criticising the Fed model, arguing that it describes how investors set prices but does a poor job of forecasting long-term stock returns.
Earnings yield also says nothing about growth or quality. A company with a 10% yield and shrinking profits can be a worse buy than one with a 3% yield and rising profits. Use it to gauge broad stock valuation against rates, and pair it with growth measures when you judge a single company.
Key Takeaways
- Earnings yield equals earnings per share divided by share price, the inverse of the P/E ratio.
- Expressing earnings as a percentage lets you compare stocks directly with bond yields and cash rates.
- The gap between the market’s earnings yield and the 10-year Treasury yield is a common, rough measure of the equity risk premium.
- Rising bond yields shrink that premium, which helps explain why higher interest rates tend to push stock valuations down.
- The comparison is imperfect because earnings are not paid out in full, can fall, and tend to grow with inflation while bond coupons stay fixed.
Is earnings yield the same as dividend yield?
No. Earnings yield counts all profit per share, while dividend yield counts only the cash paid out. A company that pays no dividend still has an earnings yield.
What is a good earnings yield?
There is no fixed level. Investors judge it against bond yields and inflation, and a yield of 5% looks generous when Treasuries pay 2% and thin when they pay 6%.
Can earnings yield be negative?
Yes, when a company loses money. Unlike a negative P/E, a negative earnings yield still ranks correctly, which is one reason screens often prefer it.
Does a high earnings yield mean a stock is undervalued?
Not necessarily. A high yield can signal that investors expect earnings to fall or see the business as risky.
