Earnings Yield Explained: How to Compare Stocks to Bonds and Find Value

Most investors know the P/E ratio. Fewer know its more useful cousin: earnings yield.

Earnings yield flips the P/E ratio on its head, expressing valuation as a percentage. This simple change makes it directly comparable to bond yields, dividend yields, and other income metrics — unlocking insights that P/E alone can't provide.

This guide explains what earnings yield is, how to calculate it, and how to use it to make better investment decisions.

What Is Earnings Yield?

Earnings yield measures how much a company earns relative to its stock price, expressed as a percentage.

The Formula

code-highlight
Earnings Yield = Earnings Per Share (EPS) / Stock Price × 100

Or equivalently:

Earnings Yield = 1 / P/E Ratio × 100

Example

code-highlight
Stock price: $50
Earnings per share: $4
P/E ratio: 12.5 ($50 / $4)

Earnings Yield = $4 / $50 = 8%

Or: 1 / 12.5 = 8%

Interpretation: For every $100 invested, the company earns $8 on your behalf.

Earnings Yield vs. P/E Ratio

Both measure the same relationship — just from different angles.

Why Earnings Yield Is More Useful

1. Directly comparable to other yields

P/E of 20 vs. 4% bond yield — hard to compare. Earnings yield of 5% vs. 4% bond yield — easy to compare.

2. Works with negative P/E

A stock losing money has a negative P/E (meaningless). It also has a negative earnings yield (clearly bad).

3. Intuitive percentage format

"8% earnings yield" is immediately understandable. "P/E of 12.5" requires mental conversion.

4. Enables cross-asset comparison

Compare stocks to bonds, REITs, or any income investment using the same metric.

Types of Earnings Yield

Trailing Earnings Yield

Uses the last 12 months of actual earnings.

code-highlight
Trailing Earnings Yield = TTM EPS / Current Price

Pros: Based on real, reported earnings Cons: Backward-looking, may not reflect future

Forward Earnings Yield

Uses estimated earnings for the next 12 months.

code-highlight
Forward Earnings Yield = Forward EPS Estimate / Current Price

Pros: Forward-looking, reflects expectations Cons: Estimates can be wrong

CAPE Earnings Yield

Uses the cyclically adjusted P/E (Shiller P/E) — 10-year average inflation-adjusted earnings.

code-highlight
CAPE Earnings Yield = 1 / CAPE Ratio

Pros: Smooths out business cycle fluctuations Cons: Very slow to reflect changes

Free Cash Flow Yield

Substitutes free cash flow for earnings — often more reliable.

code-highlight
FCF Yield = Free Cash Flow Per Share / Stock Price

Pros: Cash is harder to manipulate than earnings Cons: FCF can be volatile year to year

How to Use Earnings Yield

Use 1: Compare Stocks to Bonds

The most powerful application of earnings yield.

The comparison:

• Stocks: Earnings yield (e.g., 5%)
• Bonds: Treasury yield (e.g., 4%)

Equity Risk Premium:

code-highlight
Equity Risk Premium = Earnings Yield - Treasury Yield

Example:

code-highlight
S&P 500 earnings yield: 5.5%
10-year Treasury yield: 4.0%
Equity risk premium: 1.5%

Interpretation:

Use 2: Compare Stocks to Each Other

Rank stocks by earnings yield to find relative value.

Example Portfolio Comparison:

Stock A offers double the earnings yield of Stock B — potentially more value.

Use 3: Evaluate Market Valuation

Track the S&P 500's earnings yield over time.

Historical Context:

Use 4: Income Comparison

Compare earnings yield to dividend yield to understand retained earnings.

code-highlight
Retained Earnings Yield = Earnings Yield - Dividend Yield

Example:

code-highlight
Earnings yield: 6%
Dividend yield: 2%
Retained earnings: 4%

Interpretation: The company retains 4% of your investment value each year for reinvestment and growth.

The Fed Model

The Fed Model is a simple framework comparing stocks to bonds.

How It Works

code-highlight
If Earnings Yield > 10-Year Treasury Yield → Stocks undervalued
If Earnings Yield < 10-Year Treasury Yield → Stocks overvalued
If Earnings Yield ≈ 10-Year Treasury Yield → Fair value

Example

code-highlight
S&P 500 earnings yield: 5.0%
10-year Treasury: 4.5%
Fed Model says: Stocks slightly undervalued

Limitations of the Fed Model

1. Ignores growth Stocks can grow earnings; bonds have fixed payments. A 5% earnings yield with 10% growth may be better than a 6% bond yield.

2. Ignores risk Stocks are riskier than Treasuries. A premium is justified.

3. Historically mixed results The model has worked in some periods, failed in others.

4. Interest rate distortions Near-zero rates made almost any stock look "cheap" by this model.

Best use: As one data point among many, not a standalone decision tool.

Earnings Yield by Sector

Different sectors have different typical earnings yields.

Key insight: Compare earnings yields within sectors, not across them. A 4% tech earnings yield may be cheap; a 4% utility earnings yield may be expensive.

Earnings Yield and Value Investing

Earnings yield is a core value investing metric.

The Value Proposition

High earnings yield = cheap valuation (potentially)

Ben Graham's approach: Look for stocks with earnings yields significantly above bond yields.

Joel Greenblatt's Magic Formula: Ranks stocks by earnings yield and return on capital, buying the highest-ranked stocks.

Screening for Value

High earnings yield screen:

• Earnings yield > 8%
• Positive earnings (profitable)
• Market cap > $1 billion (avoid tiny stocks)
• Debt/equity < 1 (not over-leveraged)

What you'll find: Financials, energy, beaten-down industrials, out-of-favor sectors.

The Value Trap Warning

High earnings yield doesn't always mean good value.

Reasons for high earnings yield (cheap stock):

• Truly undervalued (opportunity)
• Earnings about to decline (value trap)
• High risk business (deserves discount)
• Cyclical peak earnings (unsustainable)
• Accounting issues (fake earnings)

Due diligence required: Always ask why the stock is cheap.

Earnings Yield vs. Dividend Yield

Both are yields, but they measure different things.

The Relationship

code-highlight
Earnings Yield = Dividend Yield + Retained Earnings Yield

Example:

code-highlight
Stock A: EPS $5, DPS $2, Price $50
- Earnings yield: 10%
- Dividend yield: 4%
- Retained: 6%

Stock B: EPS $3, DPS $2.50, Price $50
- Earnings yield: 6%
- Dividend yield: 5%
- Retained: 1%

Analysis:

• Stock A retains more for growth
• Stock B pays out most of earnings
• Depends on your goal (income vs. growth)

Which Matters More?

Use earnings yield when:

• Comparing overall value
• Growth is important
• Company reinvests profitably

Use dividend yield when:

• You need current income
• Evaluating income stocks
• Payout sustainability matters

Calculating Earnings Yield: Step by Step

Method 1: From EPS and Price

code-highlight
1. Find trailing twelve month (TTM) EPS
2. Find current stock price
3. Divide EPS by price
4. Multiply by 100 for percentage

Example:
EPS (TTM): $6.50
Price: $85
Earnings Yield = $6.50 / $85 × 100 = 7.6%

Method 2: From P/E Ratio

code-highlight
1. Find the P/E ratio
2. Divide 1 by P/E
3. Multiply by 100 for percentage

Example:
P/E: 18
Earnings Yield = 1 / 18 × 100 = 5.6%

Method 3: For an Index (S&P 500)

code-highlight
1. Find index level (e.g., 4,500)
2. Find aggregate EPS (e.g., $220)
3. Divide EPS by index level
4. Multiply by 100

S&P 500 Earnings Yield = $220 / 4,500 × 100 = 4.9%

Practical Applications

Application 1: Is the Market Cheap or Expensive?

Track these metrics:

• S&P 500 trailing earnings yield
• S&P 500 forward earnings yield
• 10-year Treasury yield
• Historical averages

Quick assessment:

Application 2: Stock Selection Screen

High earnings yield + quality screen:

code-highlight
Earnings yield > 7%
ROE > 15%
Debt/Equity < 0.5
5-year earnings growth > 5% annually
Market cap > $2 billion

Application 3: Portfolio Allocation

Adjust stock/bond allocation based on relative yields:

Application 4: Individual Stock Evaluation

Checklist:

1. Calculate earnings yield (trailing and forward)
2. Compare to sector average
3. Compare to stock's own history
4. Compare to 10-year Treasury
5. Assess if premium/discount is justified

Earnings Yield Limitations

Limitation 1: Earnings Quality

Reported earnings can be manipulated. High earnings yield on low-quality earnings is a trap.

Check: Compare to free cash flow yield.

Limitation 2: Cyclicality

Cyclical companies have high earnings at peak, low at trough. Earnings yield can be misleading.

Check: Use normalized or average earnings.

Limitation 3: Growth Ignored

A 3% earnings yield with 20% growth may be better than 10% yield with no growth.

Check: Consider PEG ratio or growth-adjusted metrics.

Limitation 4: One-Time Items

Special charges or gains distort EPS and thus earnings yield.

Check: Use adjusted or operating EPS.

Limitation 5: Leverage Effects

Heavily indebted companies can show high earnings yield that's unsustainable.

Check: Look at enterprise value metrics (EV/EBIT) instead.

Earnings Yield in Different Market Environments

Low Interest Rate Environment (2010-2021)

• Treasury yields near zero
• Almost any earnings yield looked attractive
• Fed Model showed stocks "cheap" for years
• Justified high stock valuations

Lesson: Relative comparisons must account for rate environment.

Rising Interest Rate Environment

• Treasury yields increase
• Earnings yields must compete with higher bond yields
• Stocks become relatively less attractive
• Valuations compress (P/E ratios fall, earnings yields rise)

Lesson: Watch the direction of rates, not just the level.

High Inflation Environment

• Earnings may be inflated by nominal growth
• Real earnings yield matters (earnings yield minus inflation)
• Bonds suffer; stocks may maintain real value

Lesson: Consider real (inflation-adjusted) earnings yield.

Quick Reference: Earnings Yield Cheat Sheet

Key Formulas

Interpretation Guide

Quick Comparisons

Frequently Asked Questions

What is earnings yield?

Earnings yield is a stock's earnings per share divided by its stock price, expressed as a percentage. It's the inverse of the P/E ratio. A stock with a P/E of 20 has an earnings yield of 5% (1/20). It shows how much earnings you get for each dollar invested.

What is a good earnings yield?

A "good" earnings yield depends on interest rates and market conditions. Generally, 5-8% is reasonable, above 8% may indicate value (or risk), and below 4% suggests expensive valuation. Compare to the 10-year Treasury yield — stocks should offer higher earnings yield to compensate for risk.

How is earnings yield different from dividend yield?

Dividend yield only measures cash dividends paid out. Earnings yield measures total earnings (including retained earnings). A company earning $5 per share paying $2 in dividends has 4% dividend yield at $50, but 10% earnings yield. Earnings yield captures full earning power.

Why compare earnings yield to bond yields?

Comparing earnings yield to Treasury yields helps determine if stocks are attractive versus bonds. If stocks yield 6% earnings and bonds yield 4%, stocks offer a premium for taking equity risk. If bond yields exceed earnings yield, bonds may be more attractive on a risk-adjusted basis.

What is the Fed Model?

The Fed Model compares the S&P 500 earnings yield to the 10-year Treasury yield. When earnings yield exceeds Treasury yield, stocks are considered undervalued. When Treasury yield exceeds earnings yield, stocks are overvalued. It's a simple framework but has limitations.

Related Articles

Deepen your valuation knowledge:

• Stock Valuation Guide — Master P/E, P/S, and other key ratios
• Dividend Investing Guide — Compare earnings yield to dividend yield
• How to Read Financial Statements — Understand where earnings come from
• How to Pick Stocks — Use earnings yield in stock selection
• Market Cycles Guide — Valuation through market phases