Earnings Yield: Definition, Formula & Calculation

Instructor: Douglas Stockbridge

DJ Stockbridge is currently pursuing a Masters degree in Accounting.

In this lesson, you will learn how to calculate earnings yield. You will then go through an example of the calculation, and then use the new knowledge to help your grandmother choose between two investment options.

Your Grandma needs help!

'I'm so glad you are home,' stammered your grandmother as she pushed through the front door of your house. You had been expecting to see her. You just didn't expect to see her so out of breath. Before you arrived home, a friend at the grocery store said your grandmother had just won $10,000 at a local blueberry pie contest (It was about time she won. Everyone knows she has the best pie in the County!). Right then, you knew it would only be a matter of time before she came to ask for your advice on how to invest the money. Everyone in your family turns to you for investment advice.

'I'm sure you've heard this, but I finally won the Blueberry Fields Pie Contest! Now I need your help investing the money.' 'Of course, I'd love to help' you reply. 'Great, I just came from visiting my investment broker and she said I can invest the money in one of two companies whose shares are listed in the Stock Market. She didn't give me very much information about the two companies however. She said one company is a large snack-food manufacturer named Big Cheese and the other is a large, east coast department store called Big Box. She said the companies are very similar in terms of future growth, risks and both management teams are conservative. The only difference she mentioned is one share of Big Cheese can be bought at an earnings yield of 10%, while one share of Big Box can be bought at an earnings yield of 8%. What is the earnings yield she refers to?'

'Good question. The earnings yield is a calculation of the company's past 12-months earnings per share divided by the current market price of one share. For example, I've pulled up Big Cheese's 2016 financial information. Over the past 12 months the company has generated $1.25M in earnings (also called net income or profit after tax). There are currently 1M shares outstanding, so earnings per share is $1.25M / 1.0M shares = $1.25 per share. And the price for you or me to buy one share of Big Cheese is $12.25. The $12.50 is referred to as the market price of one share. These are the prices you'll see reported in Stock Market exchanges on Wall Street like the New York Stock Exchange or the NASDAQ. To calculate Big Cheese's earnings yield we divide earnings per share of $1.25 by the market price of $12.50 to get 10%. We can do the same for Big Box. Over the past 12 months they generated $2.5M in earnings and there are currently 5M shares outstanding, so earnings per share is $2.5M / 5M = $0.50 per share. And one share of Big Bix can be bought for $6.25. Its earnings yield is then $0.50 divided by ….'

'…. $6.25 which equals 8%,' answers your grandmother. Oh, I think I understand now! And all else being equal, I want to invest in the company with the higher earnings yield, right?'

'That's exactly right,' you reply. 'Earnings yield is a measure of your return on investment. If you bought one share of the company, you are a part-owner of that company and are entitled to your share of the company's earnings. If we bought one share of Big Cheese, for example, at $12.50. Next year, if the company produced the same $1.25 in earnings per share, we will have earned $1.25 on our $12.50 investment for a 1-year return of 10%. If Big Cheese continued to produce the same result you will continue to earn $1.25 every year, or a return of 10% per year on your investment.'

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