Earnings yield is a measure of a company’s earnings relative to its market cap. Owners of a stock can consider a company’s earnings yield as a measure of total return on their investment into the company.

 

 Calculating Earnings Yield

 

Consider for a minute that you own the entire 3M company (Ticker: MMM). To buy the whole company today, you would pay about $95 billion (It’s market cap – shown below from Yahoo Finance):

MMM_market_cap

 

 

That $95 billion dollar investment has net earnings of approximately $4.66 billion, per the company’s latest 10-k filing:

 

3M Income Statement
3M Income Statement

 

 

To find the earnings yield of 3M, simply divide the company’s net income by its market cap:

 

Earnings Yield Equation.
Earnings Yield Equation.

 

 

Using the information above, a market cap of $95.14 billion and Net Income of $4.659 billion, we find 3M’s Earnings Yield to be:

 

$4.659B ÷ $95.14B = 4.89%

 

Or, earnings yield can also be calculated using per share data, by dividing EPS (Earnings Per Share) by the company’s price per share:

 

Another Earnings Yield Equation.
Another Earnings Yield Equation.

 

 

Using $145.41 as the share price, as shown above and $6.83 earnings per share:

 

$6.83 ÷ $145.41 = 4.69%

 

(The slight difference comes from rounding off the $95.14 billion market cap and $4.659 billion in Net income)

 

 

Also note, Earnings Yield is simply the inverse of the P/E ratio:

1 ÷ 21.07 = 4.75%

 

(Again, slight differences due to rounding and Yahoo Finance’s calculation of EPS based on past quarter earnings)

 

 

Using Earnings Yield

 

If you owned the entire company of the 3M, the company would generate $4.659 billion each year in additional money to spend as you please, relating this to what you paid for the company ($95.14 billion), produces a yield much like a dividend yield or bond yield.

 

An owner of 3M can consider themselves getting a return of about 4.89% on their investment. Unlike a dividend yield or bond yield however, they may not immediately get to see that money like a dividend or bond payment, as some of that will inevitably be reinvested back into the company.

 

You can compare earnings yield of multiple companies to see which company is generating higher returns, based on earnings yield, for their shareholders. Below lets consider 3M’s numbers against Johnson and Johnson Company (Ticker: JNJ), which as I write this has a market cap of about $298 billion and a net income of $13.83 billion.

 

To calculate JNJ’s earnings yield:

 

$13.83 billion ÷ $298 billion = 4.64%

 

Meaning an owner of JNJ can consider themselves getting a 4.64% return on their investment last year.

 

What does this tell investors?

3M has been doing a slightly better job at generating more earnings based on its market cap than Johnson and Johnson Co.

 

Over time, if this trend continues, this should be represented by a more rapidly increasing share price for 3M over JNJ, as retained earnings build up. Though short term fluctuations will obviously occur.

 

Comparing Earnings Yield to Treasury Yields

 

Another useful application of earnings yield is to compare a company, sector or the market as a whole’s earnings yield with the yield on the 10 year Treasury bond.

 

Because a 10 year treasury bond is considered a “risk free” investment, a company’s, sector’s or the general market’s earnings yield should be higher than the yield on a 10 year treasury bond.

Investing in a company’s stock has inherent risks that a 10 year treasury bond does not have. So for, example if you could get 6% from a treasury bond today, but 3M had an earnings yield of only 4%, treasury bonds would be pretty tempting.

 

In the The Tao of Warren Buffett,  Mary Buffett gives an example:

 

“Let’s say today you can buy the entire company of Yahoo (Ticker YHOO) for $44 billion, and it would earn you $1.8 billion per year. Do you pull the trigger? You can also invest $44 billion in U.S. treasury bonds and make $2.2 billion per year risk free. Which one looks like the better investment? What one looks like the gamble?”

 

The book was written back in 2006, so the numbers are not the same today. But we can use that idea and put it to use comparing an investment in 3M above.

We showed already that $95.14 billion buys the entire company of 3M, and it would generate a net income of $4.659 billion. As a write this, the 10 year Treasury bond yields 2.64%, so $95.14 billion in 10 year U.S. treasury bonds would net you about $2.47 billion per year. As it should, 3M generates a higher earnings yield than the yield on the 10 year treasury bond. Now it is up to you to decide if that additional yield is worth the risk of owning the stock.

 

 

A good source of data for the S&P 500 earnings yield and 10 year treasury data is Nobel Prize economist Robert Schiller’s website: http://www.multpl.com/ where you can see the latest calculations of The S&P 500’s earnings yield and historical data:

10_year_treasury_rate

SP_500_earnings_yield

 

 

 

 

Here is how a few others define Earnings Yield:

Benjamin Graham:

Interpretation of Financial Statements, Defines Earnings Yield as:

“ The ratio of the market price to the annual earnings. For example: A stock earning $6 annual and selling at $50 shows an earnings yield of 12%”

 

 

 

 

[ois skin=”Bottom of Pages”]