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 stocks with higher earnings yield. This is because stocks with higher earnings yield have the potential of providing comparatively greater returns.
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.
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 comparison of stocks with fixed-income securities.
Screening Parameters
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 of generating 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.
Our Choices
Below we have highlighted five of the 40 stocks that made it through the screen.
ArcelorMittal MT: Luxembourg-based ArcelorMittal is the world’s leading steel and mining company. It remains on track with the cost-reduction program that aims to optimize costs and increase steel shipment volumes. The Zacks Rank #1 firm is also focused on shifting to high-added value products — including automotive steel line — that offer growth visibility. The consensus estimate for 2021 sales and earnings implies year-over-year growth of 9.2% and 692.2%, respectively.
Royal Dutch Shell RDS.A: Netherlands-based Shell — which presently sports a Zacks Rank #1 — is an integrated oil and gas major. The company’s position as a leading liquefied natural gas producer — thanks to the BG acquisition — should help it meet the fuel’s growing demand, and boost top as well as bottom-line growth. Shell’s cost-containment efforts and green energy targets are praiseworthy. The consensus estimate for 2021 sales and earnings implies year-over-year growth of 48.9% and 166.9%, respectively.
Magna International MGA: Headquartered in Canada, Magna is a manufacturer and supplier of complete automotive components. Its broad range of product and service offerings offers the firm a competitive edge. Sharp focus on innovation and technology development, along with program launches is likely to boost its prospects. Magna currently flaunts a Zacks Rank #1. The consensus estimate for 2021 sales and earnings implies year-over-year growth of 25% and 88%, respectively.
Moderna, Inc. MRNA: Cambridge, MA-based Moderna is a clinical-stage pharmaceutical company, primarily focused on discovering and developing messenger RNA (mRNA)-based therapies. Several promising mRNA-based pipeline candidates in its portfolio augur well for the firm. Coronavirus vaccine development is also encouraging. Moderna currently carries a Zacks Rank #2. The consensus estimate for 2021 sales and earnings implies year-over-year growth of 1,855.5% and 1,201%, respectively.
Winnebago Industries WGO: Winnebago is one of the leading producers of recreational vehicles in the United States. The Zacks Rank #2 company has been riding on strength of its acquisitions, including Newmar, Grand Design and Chris-Craft. Winnebago’s increasing free cash flow and strengthening balance sheet enable it to consistently enhance shareholder value and outperform the marketplace. The Zacks Consensus Estimate for fiscal 2021 earnings and sales implies year-over-year growth of 37% and 130%, respectively.
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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
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