INVESTOR LETTER #106
Earnings Yield
Earnings Yield tells you how much profit a company generates each year relative to the price you pay for its stock. Instead of asking, 'How expensive is this stock?', it asks, 'If I buy this business today, what percentage of my investment is represented by this year's earnings?' It is the opposite of the P/E ratio and is a useful way to compare stocks with other investment opportunities such as bonds or fixed deposits.
INVESTOR NOTE
A business owner thinks in decades. A speculator thinks in minutes.
Buying a Rental Apartment
Imagine you're thinking about buying an apartment for ₹1 crore. Before making the purchase, you naturally ask one question: 'How much rent will this apartment generate every year?' If it earns ₹8 lakh annually, that's an 8% return before considering future growth. When investing in stocks, earnings yield asks a very similar question. Instead of rental income, you're looking at the company's annual earnings.
Looking Beyond the Share Price
Many beginners focus only on whether a stock costs ₹100 or ₹5,000 per share. But the share price alone tells you almost nothing. What matters is how much profit you're receiving for the price you pay. A high-priced stock can actually be cheap, while a low-priced stock can be very expensive.
What Is Earnings Yield?
Earnings Yield measures the company's annual earnings as a percentage of its current market value. It tells investors how much profit the business is generating relative to the amount they are paying for the stock today.
Thinking Like a Business Owner
Imagine buying an entire business instead of just one share. One of the first questions you'd ask is, 'If I pay this much, how much profit does this business generate every year?' Earnings Yield helps answer exactly that question.
The Opposite Way of Looking at P/E
Most investors are familiar with the Price-to-Earnings (P/E) ratio. Earnings Yield simply flips the perspective. Instead of asking how many years of earnings you're paying for, it tells you what percentage return those earnings represent relative to today's price.
Higher Isn't Always Better
A very high earnings yield may indicate an undervalued opportunity—but it can also signal serious business problems. The market may be expecting profits to decline sharply in the future. Numbers should always be understood in the context of the business.
Growth Changes the Picture
Two companies can have the same earnings yield today, but one may be growing profits at 20% a year while the other isn't growing at all. Although their current earnings look identical, the growing business may deserve a higher valuation because its future earnings are likely to be much larger.
Comparing Different Investment Choices
Earnings Yield becomes especially useful when comparing stocks with other investments. If a stock offers an attractive earnings yield and you believe its profits will continue growing, it may provide better long-term returns than investments with fixed income. Of course, stocks also come with greater uncertainty.
One Year's Earnings Aren't Enough
A single year's profit can be unusually high or unusually low due to temporary events. Investors should study whether earnings are sustainable by looking at several years of financial performance rather than relying on one number.
Use It Alongside Other Metrics
Earnings Yield is a helpful starting point, but it should never be used alone. Combine it with business quality, growth prospects, return on capital, debt levels, free cash flow, and management quality before making an investment decision.
Simple Metrics Can Be Powerful
Some of the best investing tools are also the simplest. Earnings Yield quickly tells you whether you're paying a high or low price relative to current profits. When combined with thoughtful business analysis, it becomes a valuable part of your valuation toolkit.
One Question Before You Invest
Whenever you look at a stock, ask yourself: 'For every ₹100 I'm investing today, how much profit is this business currently earning—and do I believe those earnings will grow in the future?' The answer is often more useful than looking at the share price itself.
INVESTOR PRINCIPLE