Investors often use P/E ratio and other valuation metrics while picking stocks that are undervalued. However, it is difficult to use P/E ratio to compare stocks with fixed income securities. This is where its inverse – Earnings Yield – comes handy. Other things remaining constant, a stock with a higher earnings yield has the potential to provide comparatively greater returns.
Earnings Yield is calculated as (Annual Earnings per Share/Market Price) x 100.
Earnings Yield can be used to compare a stock with other stocks or with fixed income securities. It is also used to compare the performance of a market index with the 10-year Treasury yield.
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 scenario, investing in the stock market would be a better option for a value investor.
However, you need to keep in mind that T-bills are risk free, while investing in stocks always comes with a caveat. Hence, it would be a good idea to add a risk premium to the Treasury yield while comparing it with the earnings yield of a stock or the overall market.
The Winning Strategy
We have set Earnings Yield greater than 10% as our primary screening criterion, but it alone cannot be used for selecting stocks that have the potential to generate solid returns. So, we have added the following parameters to the screen:
Estimated EPS growth for the next 12 months greater than 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 $5.00.
Zacks Rank less than 3: Stocks with a Zacks Rank #1 (Strong Buy) or #2 (Buy) generally outperform their peers in any type of market environment.
Here are five of the 10 stocks that made it through the screen:
Trinseo SA (TSE - Free Report)
CVR Refining, LP
Air Methods Corp.
Altisource Residential Corporation
Eagle Point Credit Company Inc. (ECC - Free Report)
You can get the rest of the stocks on this list by signing up now for a 2-week free trial to the Research Wizard stock picking and backtesting software. You can also create your own strategies and test them first before making investments.
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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.
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