Below 4% (P/E above 25): expensive
Priced for growth, and below the risk-free rate. You're paying up today for earnings that haven't arrived yet.
Definition
What is earnings yield?
Earnings yield is earnings per share divided by share price (simply the inverse of the P/E ratio) expressed as a percent. A stock with a P/E of 20 has a 5% earnings yield. Framing valuation as a yield lets you compare a stock's earnings return directly to bond yields, which is exactly how Greenblatt's Magic Formula and the classic 'Fed model' use it.
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Short answer
Earnings yield flips P/E into something you can compare to a bond. A 6% earnings yield against a 4% Treasury is a 2-point spread. Greenblatt pairs a high earnings yield (cheap) with high ROIC (quality) - cheapness and quality in one screen.
How to read earnings yield
4-6% (P/E ~16-25): fair
A normal range for quality growers in a moderate interest-rate environment.
6-8% (P/E ~12-16): attractive
A clear premium over Treasuries. Classic value territory for profitable companies.
Above 8% (P/E below 12): cheap or risky
A bargain or a market warning. Confirm the earnings are real, recurring, and durable.
Why Greenblatt uses it
A stock at $100 with $6 of EPS has a 6 percent earnings yield: the same information as a 16.7x P/E, just expressed as a return. Against a 4 percent ten-year Treasury, that's a 2-percentage-point equity risk premium you can reason about directly.
Greenblatt's Magic Formula ranks the whole market on earnings yield AND return on invested capital together. Cheap on its own can be a value trap; cheap plus high-quality: a high earnings yield on a high-ROIC business, is the combination that has historically outperformed.
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Related
- What is the P/E ratio? - the same number inverted, price over earnings instead of earnings over price.
- What is the Magic Formula? - Greenblatt's pairing of a high earnings yield with a high ROIC.
- What is FCF yield? - the cash-based cousin of earnings yield, harder to manipulate.
- Top Magic-Formula stocks today - the live ranking of cheap, high-ROIC stocks.
Compare stocks to bonds in one number
invest-like surfaces earnings yield and ROIC together inside its Greenblatt fit-score, so you see cheapness and quality side by side.
Educational only. invest-like is not a registered investment adviser; nothing here is personalised investment advice. Always do your own research and consider your individual circumstances.