Earnings yield

A P/E of 15 is a number without units. Turn it upside down and it becomes 6.67%, which is something an investor can actually compare with the 7.1% a government bond pays.

That is the whole purpose of earnings yield. It puts equity on the same scale as debt and asks the blunt question: for every hundred rupees I pay for this share, how many rupees of profit does the business earn for me?

The workbook builds up to it in stages. Dividend yield comes first — dividend per share over price — but dividends are only the part of the profit paid out, so when dividend yields are low the analyst moves "a step higher" to earnings yield, which counts the whole profit whether distributed or retained.

The comparison against bonds is the point of the exercise. In Chapter 10.7.1 the workbook sets a 10% dividend yield against a 10% bond coupon taxed at 30%, argues that the equity is offering a better post-tax return, and adds that equity carries upside if earnings grow while a bond redeems at par.

It then applies the brake: a yield higher than comparable stocks may look like a value pick and may not necessarily be so. A high payout can signal limited avenues for expansion, which caps capital appreciation. The analyst must read the market-determined metric alongside the companion variables — P/E against growth and ROE, EV/EBITDA against return on investment.

Earnings yield = EPS ÷ Current price × 100

P/E ratio      = Current price ÷ EPS

Earnings yield = 1 ÷ P/E

A public sector bank share trades at Rs 195 with estimated EPS of Rs 13:

Earnings yield = 13 ÷ 195 = 6.67%       P/E = 195 ÷ 13 = 15.0×

The 10-year government bond yields 7.10%. The equity is priced to earn 43 basis points less than the sovereign, and its earnings are a forecast rather than a contract.

Compare a cement company at Rs 480 with EPS of Rs 60:

Earnings yield = 60 ÷ 480 = 12.50%      P/E = 8.0×

Against the same bond, that is 540 basis points of extra earning power.

In rupees, on a Rs 50 lakh holding: the bank share represents Rs 3.33 lakh of annual earnings, the cement share Rs 6.25 lakh, and the government bond Rs 3.55 lakh of contractual interest.

Then the workbook's caution bites. Why is the cement company on 8×? If the industry is running at 71% capacity utilisation and realisations are falling, the 12.5% yield is not a bargain — it is the market pricing in earnings that are about to halve. The yield is the question, not the answer.

Chapter 10 (section 10.7.2) defines earnings yield and its reciprocal, the P/E ratio, and Sample Question 2 of that chapter asks for the earnings yield given a price of Rs 195 and EPS of Rs 13. Expect the direct calculation, and conceptual questions on whether a high or low P/E is justified by growth and risk.

• Earnings yield is EPS ÷ price; P/E is price ÷ EPS. Chapter 10's sample question turns entirely on that — the answer is 6.67%, not 15%, and 0.067% is the decimal-point trap sitting next to it.
• Earnings yield is not dividend yield. Only the payout reaches the shareholder as cash; the rest is retained in the business.
• The workbook's bond comparison in 10.7.1 treats the equity yield as already post-tax. Since FY 2020-21, dividends are taxed in the investor's hands at slab rate, so the comparison as printed flatters equity. Answer the chapter as written; know the current position.
• Say which EPS. Trailing and forward earnings give different yields, and the workbook says the period of reference is a matter of the analyst's judgement.
• A loss makes it negative and the P/E meaningless. Chapter 10.7.5 sends you to EV/Sales in that case, because sales can never be negative.
• It is an equity measure. Two companies with the same operations and different debt have different earnings yields — which is why an acquirer uses EV/EBITDA instead.