If you are not sure whether to invest your money in bonds or stocks, an important parameter, which can show you the right direction, is earnings yield. It is the reciprocal of the price-to-earnings (P/E) ratio. This ratio can be effectively used for figuring out undervalued stocks. Also, this ratio is handy for comparing stocks with the market or fixed income securities.
Earnings yield can be calculated as (annual earnings per share/market price) x 100. While comparing similar stocks, the one with high earnings yield should provide higher returns.
This ratio is very useful for comparing the performance of the market with the 10-year Treasury yield. When the yield of the market index exceeds the 10-year Treasury yield, stocks can be said to be undervalued in comparison to bonds. This implies that investing in the stock market is a better choice for a value investor.
However, while T-bills are free of risks, investing in stocks always carries some inherent risks. Hence, it will be wise to add a risk premium to the Treasury yield while comparing with the earnings yield of a stock or the broader market.
The Winning Strategy
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 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.
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.
Here are four of the 18 stocks that made it through the screen:
Based in Newark, DE, Sallie Mae (SLM - Free Report) , formally known as SLM Corporation, is a bellwether in education finance in the United States, with presence in the market for over 40 years. It has a Zacks Rank #2 and an expected EPS growth rate of 19.5% for the next 3-5 years.
Based in Chicago, United Continental Holdings, Inc. (UAL - Free Report) is the holding company for both United Airlines and Continental Airlines. United Continental Holdings was formed by the merger of Continental Airlines with UAL Corp. on Oct 1, 2010. The merger created the world’s largest airline. It has a Zacks Rank #2 and an expected EPS growth rate of 20.1% for the next 3-5 years.
Summit, NJ-based Celgene Corporation (CELG - Free Report) is a global biopharmaceutical company engaged in the discovery, development and commercialization of innovative therapies. It has a Zacks Rank #1 and an expected EPS growth rate of 22% for the next 3-5 years.
San Diego, CA-based Ligand Pharmaceuticals Incorporated (LGND - Free Report) discovers, develops and markets new drugs that address critical unmet medical needs of patients. It has a Zacks Rank #2 and an expected EPS growth rate of 20% for the next 3-5 years.
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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.