Earnings Yield: The Inverse of the P/E Ratio

Key Takeaways

• Earnings yield equals earnings per share divided by price, or 1 divided by the P/E ratio.
• It puts equity profitability on the same percentage scale as bond yields for direct comparison.
• The Fed model uses earnings yield versus the 10-year Treasury yield, but it has weak forecasting power.
• Earnings yield ignores growth and capital structure, so it works best inside a peer or time-series comparison.

What It Is

The earnings yield of a stock is its trailing or forward earnings per share divided by the current share price. Because price-to-earnings and earnings yield are reciprocals, the choice between them is mostly cosmetic. A 25 P/E equals a 4 percent earnings yield; a 10 P/E equals a 10 percent earnings yield.

Index-level earnings yield is computed by aggregating earnings across constituents and dividing by aggregate market capitalization. Damodaran publishes a long history of this measure for the S&P 500 in his annual data updates, alongside the Treasury bond yield.

The Intuition

A P/E ratio of 30 sounds expensive but is hard to relate to a 4 percent bond yield without conversion. Flip the multiple and the 30 P/E becomes a 3.3 percent earnings yield, which sits below the bond. Earnings yield lets you reason about stocks the same way you reason about fixed income.

Earnings yield is not what you actually receive as a shareholder. Companies retain part of their earnings, return part as dividends, and use part for buybacks. The yield is the theoretical return on the equity capital you are paying for, assuming earnings were fully distributed, which is why it pairs naturally with bond yields.

How It Works

The basic formula is:

Earnings Yield = EPS / Price = 1 / (P/E)

Where EPS is earnings per share, usually trailing twelve months for headline reporting and forward consensus for forecasting work.

Two refinements matter in practice. Cyclically adjusted earnings yield uses ten-year average inflation-adjusted earnings in place of trailing EPS, the CAPE construction popularized by Robert Shiller. Enterprise-value earnings yield, used in Joel Greenblatt's "magic formula," divides EBIT by enterprise value to neutralize capital structure differences across firms.

The Fed model, popularized by Ed Yardeni in the late 1990s, compares the forward earnings yield on the S&P 500 to the 10-year Treasury yield. When earnings yield exceeds bond yield, stocks look cheap; when bond yield exceeds earnings yield, stocks look expensive. Academic work, including critiques in the CFA Institute curriculum, finds that the Fed model has little long-run predictive power because it ignores inflation expectations and equity growth.

Worked Example

A large-cap consumer staples firm trades at $120 per share with trailing EPS of $6.00 and forward EPS estimates of $6.60.

• Trailing P/E = 120 / 6.00 = 20.0
• Trailing earnings yield = 6.00 / 120 = 5.00 percent
• Forward earnings yield = 6.60 / 120 = 5.50 percent

If the 10-year Treasury yields 4.20 percent at the same moment, the forward earnings yield gap is 5.50 - 4.20 = 1.30 percentage points. The stock looks reasonably valued versus bonds, though far less compelling than it would have been at a 7 percent earnings yield with the same bond yield.

A second look using EV/EBIT changes the picture. If enterprise value is $30 billion and EBIT is $1.8 billion, EV/EBIT is 16.7 and the EBIT-based earnings yield is 6.00 percent, slightly higher than the equity-only earnings yield because the firm has net cash.

Common Mistakes

1. Comparing across capital structures. Two firms with the same equity earnings yield can have very different debt loads. EV/EBIT earnings yield is the apples-to-apples version.
2. Ignoring growth. A 4 percent earnings yield in a fast-growing firm and a 4 percent earnings yield in a no-growth firm are not equivalent. Earnings yield is one input, not the answer.
3. Mixing trailing and forward. Forward earnings yield uses analyst forecasts; trailing uses reported numbers. Cross-firm peer sets should use the same basis for every name.
4. Treating the Fed model as causal. The earnings yield to bond yield relationship is descriptive, not a market-timing rule. Empirical studies find limited predictive value.
5. Forgetting nominal vs real. Bond yields are nominal; earnings power grows roughly with inflation. CAPE-style yields adjust for this by using real averaged earnings.

Frequently Asked Questions

What is earnings yield in simple terms? Earnings yield is a company's annual earnings expressed as a percentage of its share price. It is the inverse of the P/E ratio and lets you compare a stock to bond yields on the same scale.

How does earnings yield affect investment decisions? Investors compare earnings yield to bond yields and to peer earnings yields to gauge relative attractiveness. A high earnings yield can signal a cheap stock, weak growth expectations, or higher risk, so context matters.

What is a real-world example of earnings yield? The S&P 500 forward earnings yield has averaged around 6 percent across recent decades, well above the average 10-year Treasury yield in most years, though the gap narrowed sharply during the late 1990s tech bubble.

How can investors use earnings yield effectively? Use forward earnings yield for the cleanest comparison to current bond yields. Look at it alongside growth, payout, and EV-based yields, and prefer a five- or ten-year average earnings yield for cyclical firms.

How is earnings yield different from dividend yield? Earnings yield uses all reported earnings, including amounts retained or used for buybacks. Dividend yield uses only the cash dividend paid out. Earnings yield will almost always be higher.

Sources

1. Damodaran, A. Chapter 18: Earnings Multiples. NYU Stern. https://pages.stern.nyu.edu/~adamodar/pdfiles/valn2ed/ch18.pdf
2. Damodaran, A. Return on Equity, Earnings Yield and Market Efficiency. Musings on Markets. https://aswathdamodaran.blogspot.com/2025/02/return-on-equity-earnings-yield-and-market.html
3. CFA Institute. Market-Based Valuation: Price and Enterprise Value Multiples. https://www.cfainstitute.org/insights/professional-learning/refresher-readings/2026/market-based-valuation-price-enterprise-value-multiples
4. Federal Reserve Bank of St. Louis. 10-Year Treasury Constant Maturity Rate (DGS10). https://fred.stlouisfed.org/series/DGS10

Disclaimer

This article is educational content only and is not financial advice. Nothing here is a recommendation to buy, sell, or hold any security. Consult a licensed advisor before making investment decisions.