Earnings Yield

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The Earnings Yield Compared to the Price-Earnings Ratio

Whether earnings yield is superior to the price-to-earnings ratio depends on the individual. When it comes to long-term investing, earnings yield is a popular choice. A price-to-earnings ratio, on the other hand, is a more accurate indicator of the potential for short-term price increases. However, both statements are nearly identical. In the end, both ratios are influenced by the share price and earnings per share, and it merely matters which of the two is in the numerator and which is in the denominator.

It is useful for investors who wish to achieve stable dividend income to assess the earnings yield, as it provides a quick glimpse into the potential yield that a share may be able to produce. As the share price rises (assuming earnings remain unchanged), the earnings yield decreases.

Earnings yields appear to be lower the more valuable/expensive an asset is and vice versa. This conclusion, however, is misleading, since value and price are not the same things. Based on both the earnings yield and the P/E ratio, the only conclusion that can be drawn is the current price (share price) in relation to the current earnings. As a result of these ratios, only limited conclusions can be drawn regarding the value of an investment. Investing in securities with high valuations or high price-to-earnings ratios can provide higher earnings over time, thus lowering the P/E ratio and increasing the earnings yield. This is exactly what growth investors are looking for. This can be seen in the case of Amazon, which initially had low earnings and therefore a high P/E ratio as almost all of its earnings were reinvested in its growth.

In contrast, investments with weak valuations and low P/E ratios, for example due to fundamental issues, can generate lower earnings over time. This, in turn, results in a higher P/E ratio and a lower earnings yield. As an example, Nokia was unable to compete with Apple & Co. in the smartphone market.

It is also possible for a high earnings yield and a low P/E ratio to indicate an undervaluation of a company, while a low earnings yield and a high P/E ratio may indicate an overvaluation. When making investment decisions, earnings yield and P/E ratio should not be viewed in isolation. It is therefore advisable to consult a specialist before investing in a company in order to carry out a comprehensive analysis.

Disadvantages of the Earnings Yield

As with P/E ratios, earnings yields vary greatly by industry, country, and year. When comparing earnings yields between companies, only companies in the same industry should be considered. A further disadvantage of earnings yield is that it is calculated retrospectively. Profits from the past are not necessarily indicative of profits in the future. Furthermore, the price of shares can fluctuate greatly in some cases. As a result, the earnings yield changes according to the selected daily price. It is possible to avoid this by using the average value of the share price. Furthermore, it is possible to distort the net profit (for example, due to one-time events). An experienced wealth manager is aware of the difficulties involved in calculating the earnings yield, as well as the P/E ratio, and can thus assist with these calculations in the best way possible.