Investors often use the P/E ratio and other valuation metrics to pick undervalued stocks with solid upside potential. One can also use another interesting ratio. Earnings yield, expressed in percentage, is calculated as (Annual Earnings per Share/Market Price) x 100. While comparing stocks, if other factors are similar, investors can look out for stocks with higher earnings yield. This is because stocks with higher earnings yield have the potential of providing comparatively greater returns.
Just like the case with dividend yield, firms with higher earnings yield are considered underpriced, while those with lower earnings yield are seen as overpriced. Earnings yield captures both the tangible and intangible yield of a firm as opposed to dividend yield, which only takes into account the tangible yield.
Importantly, earnings yield can also be used to compare the performance of a market index with the 10-year Treasury yield. For instance, when the yield of the market index is more than the 10-year Treasury yield, stocks can be considered as undervalued than bonds. In this situation, investing in the stock market would be a better option for a value investor.
Earnings Yield: Simply the Inverse of P/E
Earnings yield is nothing but the reciprocal of one of the most popular valuation metrics, i.e. the P/E ratio (stock price/earnings per share). Thus, a firm having a P/E ratio of 10.2 will logically have an earnings yield of 9.8% (100/10.2). In fact, as the concept of earnings yield is already indirectly captured in the P/E ratio, earnings yield as an investment valuation metric is not as widely used as the P/E ratio.
Having said that, it should be noted that earnings yield is an important tool for investors with exposure to both stocks and bonds. With regard to this, earnings yield can be more illuminating than the traditional P/E ratio, as the former facilitates the comparison of stocks with fixed-income securities.
We have set Earnings Yield greater than 10% as our primary screening criterion but it alone cannot be used for picking stocks that have the potential of generating solid returns. So, we have added the following parameters to the screen:
Estimated EPS growth for the next 12 months greater than or equal to the S&P 500: This metric compares the 12-month forward EPS estimate with the 12-month actual EPS. Average Daily Volume (20 Day) greater than or equal to 100,000: High trading volume implies that a stock has adequate liquidity. Current Price greater than or equal to $5. Buy-Rated Stocks: Stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) have been known to outperform peers in any type of market environment. You can see the complete list of today’s Zacks #1 Rank stocks here. Our Choices
Below we have highlighted four of the 81 stocks that made it through the screen.
Royal Dutch Shell ( RDS.A Quick Quote RDS.A - Free Report) : Headquartered in the Netherlands, this integrated energy giant currently sports a Zacks Rank #1 and has a long-term expected EPS growth of 4%. The company has become the largest LNG producer in the world with the BG buyout. Strong liquidity profile, solid FCF generation and investor-friendly moves of the firm instill optimism. In the last reported quarter, Shell announced a $2-billion stock buyback program, which reflects steadily improving earnings and cash flows. The company’s efforts to transition to a renewable energy-focused future and attain net-zero emissions by 2050 are praiseworthy. The Zacks Consensus Estimate for 2021 sales and earnings implies year-over-year growth of 90.7%, and 333.8%, respectively. Gap ( GPS Quick Quote GPS - Free Report) : California-based Gap is one of the largest U.S. apparel companies, currently carrying a Zacks Rank #2. Gap’s powerhouse brand, Old Navy, remains a significant long-term growth opportunity. Increasing popularity of the Athleta brand, robust digital marketing investments and focus on product strategy have also been yielding positive results. The company is on track with the execution of the Power Plan 2023, aimed at portfolio optimization, margin expansion and improved cash flows. Gap’s strong financial position and commitment to increase shareholder value are other positives. The Zacks Consensus Estimate for fiscal 2022 sales and earnings implies year-over-year growth of 29%, and 204%, respectively. United States Steel ( X Quick Quote X - Free Report) : Based in Pennsylvania, this steel producer currently carries a Zacks Rank #2 and has a VGM Score of A. It is gaining from strong demand across end markets and higher domestic steel prices. The firm is witnessing strong consumer-driven demand and pent-up infrastructure demand. Investment in Big River Steel is also expected to be accretive to U.S. Steel’s earnings and generate significant synergies. Cost-saving initiatives and efforts to improve operational efficiency should drive its results. The Zacks Consensus Estimate for 2021 sales and earnings implies year-over-year growth of 102%, and 381.8%, respectively. Silicon Motion Technology ( SIMO Quick Quote SIMO - Free Report) : This Taiwan-based semiconductor company currently carries a Zacks Rank #1 and has a long-term expected EPS growth of 8%. The firm is riding on solid demand for solid-state drive controllers, and eMMC and UFS controllers. The growing adoption of embedded memory controllers amid an uptick in smartphone sales is also a positive. Increased PC sales triggered by online learning and the work-from-home wave augur well. New design wins for PCIe Gen4 SSD controllers from NAND makers also boost prospects of Silicon Motion. The Zacks Consensus Estimate for 2021 sales and earnings implies year-over-year growth of 68%, and 83%, respectively.
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