Earnings Yield Explained

Earnings yield is earnings per share divided by share price — the inverse of the P/E ratio, expressed as a percentage. It tells you the annual profit you earn for each pound invested, which lets you compare a stock against bonds, cash and other stocks on a like-for-like basis. A higher earnings yield signals a cheaper valuation.

Where this fits: earnings yield is a price lens for the fifth of the Five Criteria. It is simply the P/E ratio turned on its head, and it leads naturally to the free cash flow yield Buffett favours.

The price-to-earnings ratio is the most quoted valuation measure in the world, yet it has a quiet awkwardness: it is expressed as a multiple, not a return. “Twenty times earnings” tells you the price but not what you get for it in terms you can compare to anything else. Flip the ratio over and that problem disappears. The result is the earnings yield.

From a multiple to a return

The calculation could not be simpler:

Earnings yield = earnings per share ÷ share price = 1 ÷ P/E

A stock trading on a P/E of 20 has an earnings yield of 1 ÷ 20 = 5%. One on a P/E of 10 yields 10%. One on a P/E of 50 yields just 2%. The higher the yield, the cheaper the stock, because you are buying more profit for each pound.

You can compute it per share or for the whole company — net profit divided by market capitalisation gives the same percentage. Either way, the number now reads like an interest rate, and that is precisely the point.

Why the reframing matters

Expressing valuation as a yield unlocks a comparison that a bare P/E cannot offer: you can hold a stock up against every other place your money could go.

A government bond pays a yield. Cash in a savings account pays a yield. Another stock has its own earnings yield. Once everything is in the same units — a percentage return — you can reason about them side by side. “Is a 5% earnings yield on this company attractive when a safe bond pays 4%?” is a question you can actually answer. “Is a P/E of 20 attractive when a bond pays 4%?” is not, because the two numbers do not speak the same language.

This bond comparison is sometimes called the Fed model. The idea is straightforward: equities and bonds compete for your capital, so their yields can be weighed against each other. If a stock’s earnings yield sits well above the safe bond yield, you are being paid a premium for taking equity risk. If it sits below, you are accepting a lower return for more uncertainty, which demands a very good reason.

The link to the P/E you already know

Because earnings yield is just the P/E inverted, it quietly re-expresses rules of thumb you may already hold. A view that “a P/E above 25 is getting expensive” is identical to saying “an earnings yield below 4% is getting thin”. The advantage of the yield framing is that it makes the trade-off against other assets visible. A 4% earnings yield sounds abstract; set it beside a 4% bond that carries no business risk, and the demand it places on future growth becomes obvious. The stock must grow to justify accepting the same starting yield as something far safer. That single comparison does more to discipline a valuation than staring at a P/E ever will.

A word of caution: this comparison is a lens, not a law. Earnings grow and bond coupons do not, so a lower starting earnings yield can still win over time if the company compounds. Use the comparison to frame the decision, not to automate it.

A worked illustration

Consider a hypothetical choice, invented for illustration. You are weighing two uses of £10,000:

Option	Stated yield	Nature of the return
Company A stock (P/E 12.5)	8% earnings yield	Profit that can grow over time, but is uncertain
10-year government bond	4%	Fixed, contractual, backed by the state

The stock offers double the yield today. The bond offers certainty. The gap — four percentage points — is your compensation for bearing equity risk and the possibility that Company A’s earnings fall. Whether that gap is enough depends on how durable and growing you judge Company A’s profits to be. The earnings yield does not make the decision for you; it frames it in terms you can think clearly about.

The limits: it is still built on accounting earnings

Earnings yield is only as good as the earnings underneath it, and reported profit carries well-known distortions.

• Non-cash items. Depreciation, amortisation and write-downs affect earnings without moving cash. A company’s earnings yield can look thin while its cash generation is strong, or vice versa.
• One-off effects. A single large gain or charge can make a year’s earnings — and therefore the yield — unrepresentative. Normalise for anything unusual before trusting the figure.
• Earnings management. Profit sits at the end of a chain of estimates and can be flattered. The sterner the scrutiny you apply to the quality of earnings, the more you can trust the yield.
• It ignores the balance sheet. Like the P/E it is derived from, a plain earnings yield says nothing about debt. Two firms with the same yield can carry very different risk.

Because of these limits, many experienced investors graduate from the earnings yield to the free cash flow yield. It replaces accounting profit with the actual cash a business throws off after the investment it needs to keep running. Cash is far harder to manipulate than earnings, which is why it anchors the price test in our framework.

How to use it within the Five Criteria

Earnings yield is a fast, intuitive first read on price. Fit it into a disciplined process:

1. Use it to compare. Rank candidates against each other, against their own history, and against safe bond yields to judge whether equity risk is being paid for.
2. Normalise the earnings. Strip out one-offs so the yield reflects sustainable profit, not a lucky or unlucky year.
3. Cross-check with cash. Compare the earnings yield with the free cash flow yield. A large gap between them is a prompt to ask why — often it reveals heavy capital spending or aggressive accounting.
4. Judge quality and growth. A lower earnings yield can be entirely justified for a business with a durable moat and high returns on capital. A high yield on a declining business is often a trap.
5. Insist on a margin of safety. Even an attractive yield deserves a buffer against your being wrong. That is your margin of safety.

Used this way, the earnings yield is one of the most practical tools in valuation: it turns the ever-present P/E into a return you can reason about, and it points you straight toward the cash-based measures that matter most.

Frequently Asked Questions

How do you calculate earnings yield? Divide earnings per share by the share price, or equivalently divide 1 by the P/E ratio, then express the result as a percentage. A stock on a P/E of 20 has an earnings yield of 1 ÷ 20 = 5%. You can also compute it on a whole-company basis as net profit divided by market capitalisation.

Why compare earnings yield to bond yields? Both are returns, so they can be compared directly. If a stock yields 6% in earnings while a government bond yields 4%, you can weigh the extra 2% against the extra risk of owning equity. This framing, sometimes called the Fed model, turns an abstract P/E into a decision you can reason about.

What is a good earnings yield? There is no fixed threshold, but many value-minded investors like to see an earnings yield comfortably above the yield on safe government bonds to compensate for equity risk. The right level depends on the quality and growth of the business; a durable compounder can justify a lower yield than a fragile one.

What is the difference between earnings yield and free cash flow yield? Earnings yield uses accounting profit, which includes non-cash items and can be managed. Free cash flow yield uses the actual cash a business generates after necessary investment. The cash version is harder to distort and better reflects what you can truly earn as an owner.

Your Next Step

Earnings yield is the gateway to thinking about price as a return. The next move is to make that return cash-based.

• Read why free cash flow matters more than profit.
• See the cash version in price-to-free-cash-flow, the metric Buffett loves.
• Pressure-test a whole company with the Five Criteria scorecard calculator.

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About the author: Cameron Hayes is a senior investor relations and finance professional who has worked in IR at Nasdaq Copenhagen-listed companies including Nilfisk and Maersk Drilling. He holds an MSc from Copenhagen Business School and a BCom from the University of Ottawa, and founded Gingernomics to teach individual investors the Five Criteria framework. More about Gingernomics.

The content on Gingernomics is for educational and informational purposes only and does not constitute financial advice. Always do your own research and consult a licensed financial advisor before making any investment decisions. Past performance is not indicative of future results.