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Mastering Earnings Yield

When it comes to investing in the stock market, one of the key factors that savvy investors consider is the earnings yield of a company. But what is earnings yield, and why does it matter?

Understanding Earnings Yield

Earnings yield is a fundamental metric in the world of finance. It represents the return on investment (ROI) that an investor can expect to receive for each dollar invested in a stock. Calculated as the inverse of the Price-to-Earnings (P/E) ratio, earnings yield is expressed as a percentage and is obtained by dividing the earnings per share (EPS) by the current stock price.

High Earnings Yield Stocks

Stocks with high earnings yield tend to be a favourite among value investors. A high earnings yield implies that a company’s stock is trading at a lower price relative to its earnings. In other words, you get more earnings for your investment, making the stock appear undervalued. High earnings yield can be an indicator that the market has underestimated the company’s true worth.

Read: Earnings-Based Valuation Technique

Low Earnings Yield Stocks

On the flip side, stocks with low earnings yield may signal that a company is overvalued. These stocks have higher stock prices in relation to their earnings. While a low earnings yield does not necessarily mean a stock is a poor investment, it suggests that investors are paying a premium for each dollar of earnings, which could limit potential returns.

Let’s examine the performance of stocks in the BSE 500 index.

STOCK  Earnings Yield  Returns (6M) 

BSE 500

GMR Airports Infra -0.21% 23.00%
Info Edge (India) Ltd. -0.24% 12.60%
Tejas Networks Ltd. -0.42% 34.09%
Zee Entertainment -0.45% 33.75%
KIOCL Ltd. -0.47% 103.00%
Sunteck Realty Ltd. -0.69% 49.35%
Zomato Ltd. -0.81% 99.20%
PB Fintech Ltd. -0.92% 19.84%
Aditya Birla Fashion -1.27% 1.08%
ITI Ltd. -1.32% 197.23%

AVERAGE

57.31% 

These stocks exhibit negative earnings as well as negative P/E, resulting in negative earnings yields.

STOCK  Earnings Yield  Returns(6M)

BSE 500

FSN E-Commerce 0.04% 17.67%
Nuvoco Vistas 0.08% 8.36%
Privi Speciality Chemicals 0.10% 12.62%
Mahindra Lifespace 0.27% 37.34%
Eureka Forbes Ltd. 0.32% 28.57%
IFB Industries Ltd. 0.33% 10.72%
Birla Corporation Ltd. 0.40% 33.03%
Hitachi Energy India 0.49% 37.92%
Macrotech Developers 0.50% 73.66%
Medplus Health 0.54% 10.07%

AVERAGE

27.00% 

These stocks possess positive earnings but are characterized by remarkably high P/E ratios.

Earnings Yield and Returns

Earnings yield can have a significant impact on investment returns. Stocks with high earnings yield may present a greater potential for capital appreciation. They have room to grow, and as the market begins to recognize their true value, share prices can rise, leading to attractive returns for investors.

On the other hand, stocks with low earnings yield might experience slower capital appreciation. Overvalued stocks can be more susceptible to market corrections when the company’s actual performance does not meet investor expectations. In such cases, returns might not be as promising.

Example

Consider two companies: Company A and Company B. Company A has a high earnings yield of 10%, indicating an undervalued stock. Over the past year, its share price has steadily risen, resulting in a substantial return of 30%. In contrast, Company B has a low earnings yield of 2%, suggesting overvaluation. While its stock price increased, the return was only 5%, significantly lower than Company A’s return.

Risks and Considerations

While earnings yield is a valuable metric, it’s essential to consider it alongside other factors. Market conditions, industry trends, and company-specific variables should also be factored into your investment decisions. A high earnings yield does not guarantee success, and a low earnings yield does not spell doom. Diversification is key to managing risk in your portfolio.

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