Investors often use P/E ratio and other valuation metrics to pick undervalued stocks with solid upside potential. However, 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 the one with higher earnings yield. This is because stocks with earnings yield have the potential to provide comparatively greater returns.
You must have heard of dividend yield (Dividend per share/ Market Price), which is one of the classic metrics for valuating stocks. If we substitute dividend per share with earnings per share, we get the earnings yield. 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. Notably, earnings yield captures both the tangible and intangible yield of the firm, as opposed to dividend yield, which only takes into account the tangible yield. The ratio of dividend yield to earnings yield indicates the proportion of earnings directly distributed in the form of dividend payout.
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. In fact, with regard to this, earnings yield can be more illuminating than the traditional P/E ratio as the former facilitates comparisons 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 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 five of the 50 stocks that made it through the screen:
Lithia Motors, Inc. (LAD - Free Report) : Oregon-based Lithia Motors is one of the leading automotive retailers of new and used vehicles, and related services in the United States. It sports a Zacks Rank #1 and an expected EPS growth rate of 9.7% for the next 3-5 years.
Marathon Petroleum Corporation (MPC - Free Report) : Findlay, OH-based Marathon Petroleum is a leading independent refiner, transporter and marketer of petroleum products. This Zacks Rank #2 firm has an expected EPS growth rate of 12.1% for the next 3-5 years.
Meritage Homes Corporation (MTH - Free Report) : Based in Scottsdale, AZ, Meritage Homes is one of the leading designers and builders of single-family homes. The company carries a Zacks Rank #2 and has an expected EPS growth rate of 9% for the next 3-5 years.
Jazz Pharmaceuticals PLC (JAZZ - Free Report) : Dublin, Ireland-based Jazz Pharmaceuticals is a specialty biopharmaceutical company with focus on areas like sleep and hematology/oncology. It has a Zacks Rank #2 and an expected EPS growth rate of 11.3% for the next 3-5 years.
Barclays PLC (BCS - Free Report) : Headquartered in London, Barclays is a major global banking and financial services company. It carries a Zacks Rank #1 and has an expected EPS growth rate of 2.8% 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.