Investors often use P/E ratio and other valuation metrics while picking undervalued stocks with solid upside potential. However, it is difficult to use the P/E ratio to compare stocks with fixed income securities. This is where its inverse – Earnings Yield – gains an edge.
Earnings yield is calculated as (Annual Earnings per Share/Market Price) x 100. While comparing similar stocks, the one with the higher earnings yield has the potential to provide comparatively greater returns.
This metric is often used to compare the performance of a market index with the 10-year Treasury yield.
For instance, if the yield of the market index is more than the 10-year Treasury yield, stocks can be considered as undervalued than bonds. In such a case, 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 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 $5.00.
Buy-Rated Stocks: Stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) have been known to outperform their peers in any type of market environment.
Here are four of the 10 stocks that made it through the screen:
Banco Bilbao Vizcaya Argentaria, S.A. (BBVA - Snapshot Report) is engaged in a wide variety of banking, financial and related activities in Spain. This Rank #2 company has an expected EPS growth rate of 15.4% for the next 3–5 years.
Korea Electric Power Corp. (KEP - Analyst Report) is an integrated electric utility engaged in the generation, transmission, distribution of electricity and development of electric power resources in South Korea. This Zacks Rank #1 stock has an expected EPS growth rate of 25% for the next 3–5 years. You can see the complete list of today’s Zacks #1 Rank stocks here.
Ternium S.A. (TX - Snapshot Report) is the leading producer of flat and long steel products in Latin America. It consolidates the operations of steel companies Hylsa in Mexico, Siderar in Argentina and Sidor in Venezuela. The company carries a Zacks Rank #2 and its expected EPS growth rate for the next 3–5 years is 25.7%.
KKR & Co. L.P. (KKR - Snapshot Report) provides a range of asset management services to its investors and provides capital markets services to its firm, its portfolio companies and its clients. This Zacks Rank #2 company has an expected EPS growth rate of 20.5% for the next 3–5 years.
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.
The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.
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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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