P/E Ratio vs. EPS vs. Earnings Yield: What’s the Difference?

P/E Ratio vs. EPS vs. Earnings Yield: An Overview

The price-to-earnings (P/E) ratio, earnings per share (EPS), and earnings yield are all financial metrics used to evaluate a company.

The P/E ratio can reveal if a stock is overvalued or undervalued relative to its earnings, and it is useful for understanding a company’s profitability. The P/E ratio is calculated by dividing the price of a stock by the company’s annual earnings per share (EPS). EPS is also used to determine a company’s profitability; EPS reveals how much profit each outstanding share of stock has earned. It’s calculated by dividing the company’s net income by the total number of outstanding shares. Earnings yield is the percentage of a company’s earnings per share; it is calculated by dividing the earnings per share for the most recent 12-month period by the current market price per share.

While all of these metrics are useful for understanding a company’s profitability, when evaluating potential returns—especially across different instruments—earnings yield can provide important insights.

Key Takeaways

• The price-to-earnings (P/E) ratio, earnings per share (EPS), and earnings yield are financial metrics used to evaluate a company.
• While all of these metrics are useful for understanding a company’s profitability, when evaluating potential returns—especially across different instruments—earnings yield can offer important insights.
• The price-to-earnings (P/E) ratio reveals if a stock is overvalued or undervalued relative to its earnings.
• Earnings per share (EPS) reveals how much profit each outstanding share of stock has earned.
• Earnings yield shows the percentage of a company’s earnings per share.

Comparing Different Financial Metrics

Price-to-Earnings (P/E) Ratio

The price-to-earnings (P/E) ratio reveals if a stock is overvalued or undervalued relative to its earnings. The P/E ratio can be further broken down into two different variations:

• Trailing price-to-earnings (P/E) ratio: This is the P/E ratio based on EPS for the trailing four quarters—or 12 months.
• Forward price-to-earnings (P/E) ratio: This P/E ratio is based on future estimated EPS, such as the current fiscal or calendar year—or the next year.

The P/E ratio for a specific stock is the most useful when compared against these other metrics:

• Sector price-to-earnings (P/E) ratio: Comparing the stock’s P/E ratio to those of other similar-sized companies in its sector—in addition to the sector’s average P/E ratio—can help investors determine whether the stock is trading at a premium or discount valuation compared to its peers.
• Relative price-to-earnings (P/E) ratio: Comparing the stock’s P/E ratio with its P/E range over a specific time range reveals information about investor perception. A stock may be trading at a much lower P/E ratio currently because investors perceive that its growth has peaked.
• Price-to-earnings (P/E) to earnings growth (PEG ratio): The PEG ratio compares the P/E to future or past earnings growth. A stock with a P/E ratio of 10 and earnings growth of 10% has a PEG ratio of 1, while a stock with a P/E ratio of 10 and earnings growth of 20% has a PEG ratio of 0.5. According to this metric (the PEG ratio), an investor might conclude that the second stock (with a PEG ratio of 0.5) is undervalued compared to the first stock (with a PEG ratio of 1) when comparing these two stocks.

Important

The price-to-earnings (P/E) ratio is a very popular financial metric; earnings yield is not as widely used as a metric.

Earnings Per Share (EPS)

EPS is the bottom-line measure of a company’s profitability; it is calculated by dividing net income by the number of outstanding shares. There are different variations of the EPS metric, including fully diluted EPS (FDEPS). While EPS uses the number of outstanding shares in the denominator, FDEPS uses the number of fully diluted shares in the denominator.

Earnings Yield

Earnings yield is the reciprocal of the P/E ratio. That means, the higher the earnings yield of a stock, the lower the P/E ratio. It is calculated by dividing EPS by the stock price (E/P).

Thus, Earnings Yield = EPS / Price = 1 / (P/E Ratio), expressed as a percentage.

Consider this example: If Stock A is trading at $10 and its EPS for the past year—or trailing 12 months (TTM)—was 50 cents, it has a P/E of 20 ($10/50 cents) and an earnings yield of 5% (50 cents/$10).

If Stock B is trading at $20 and its EPS (TTM) is $2, it has a P/E of 10 ($20/$2) and an earnings yield of 10% ($2/$20).

Assuming that A and B are similar companies operating in the same sector—and with nearly identical capital structures—Stock B is a better value.

From a valuation perspective, Stock B has a much lower P/E. From an earnings yield point of view, Stock B has a yield of 10%, which means that every dollar invested in the stock would generate an EPS of 10 cents. Stock A only has a yield of 5%, which means that every dollar invested in it would generate an EPS of 5 cents.

The earnings yield also makes it easier to compare potential returns between different kinds of financial instruments, for example a stock and a bond.

Consider an investor who is trying to decide between Stock B and a junk bond with a 6% yield. One could say that comparing Stock B’s P/E of 10 and the junk bond’s 6% yield is akin to comparing apples and oranges.

However, using Stock B’s 10% earnings yield makes it easier for the investor to compare returns and decide whether the yield differential of four percentage points justifies the risk of investing in the stock (rather than the bond). Note: Even if Stock B only has a 4% dividend yield, the investor is more concerned about total potential return than actual return.

Disadvantages of Earnings Yield

Earnings yield is a particularly useful tool for investors who want to compare potential returns. However, it has the following drawbacks:

• Greater degree of uncertainty: The return indicated by the earnings yield has a much greater degree of uncertainty than the return from a fixed-income instrument.
• More volatility: Since net income and EPS can fluctuate significantly from one year to the next, the earnings yield will generally be more volatile than fixed-income yields.
• Indicative return only: The earnings yield only indicates the approximate return based on EPS; the actual return may diverge substantially from the earnings yield, especially for stocks that don’t pay dividends—or pay small dividends.

For example, suppose there’s a company, called Widget Co., that’s trading at $10, and it will earn $1 in EPS in the year ahead. If it pays out the entire amount as dividends, the company would have adividend yield of 10%. If the company doesn’t pay dividends, investors may still see an increase in returns from the company as a result of the increase in the company’s book value (and retained earnings) because the company generated profit but didn’t pay it out as dividends.

Now, assume Widget Co. is trading at book value. If its book value per share increases from $10 to $11 (as a result of the $1 increase in retained earnings), the stock will trade at $11—providing a 10% return to investors. But, what if there is a glut of widgets in the market and Widget Co. begins trading at a big discount to book value? In that case, rather than a 10% return, the investor may incur a loss from their Widget Co. holdings.

Special Considerations

Role of the Dividend Payout Ratio and Dividend Yield

One issue that often arises with a stock that pays a dividend is its dividend payout ratio; this ratio reveals the ratio of dividends paid as a percentage of EPS. The payout ratio is an important indicator of dividend sustainability. If a company consistently pays out more in dividends than it earns in net income, its dividend payment may be in jeopardy in the future. While a less-stringent definition of the payout ratio uses dividends paid as a percentage of cash flow per share, we’ll define dividend payout ratio in this section as: dividend per share (DPS) / EPS.

The dividend yield is another measure commonly used to gauge a stock’s potential return. A stock with a dividend yield of 4% and appreciation of 6% has a potential total return of 10%.

Dividend Yield = Dividends Per Share (DPS) / Price

Since the Dividend Payout Ratio = DPS / EPS, dividing both the numerator and denominator by the price gives us:

Dividend Payout Ratio = (DPS/Price) / (EPS/Price) = Dividend Yield / Earnings Yield

Let’s use Procter & Gamble to illustrate this concept. P&G closed at $74.05 on May 29, 2018. The stock had a P/E of 19.92 (based on trailing 12-month EPS) and a dividend yield (TTM) of 3.94%.

P&G’s dividend payout ratio was therefore = 3.94 / (1/19.92)* = 3.94 / 5.02 = 78.8%

*(Earnings Yield = 1 / (P/E Ratio))

The payout ratio could also be calculated by dividing the DPS ($2.87) by the EPS ($3.66) for the past year. However, this calculation requires that one knows the actual values for per-share dividends and earnings, which are generally less widely known by investors than the dividend yield and P/E ratio of a specific stock.

Thus, if a stock with a dividend yield of 5% is trading at a P/E ratio of 15 (which means its earnings yield is 6.67%), its payout ratio is approximately 75%.

How does Procter & Gamble’s dividend sustainability compare with that of telecommunications services provider CenturyLink Inc, which had the highest dividend yield of all S&P 500 constituents in May 2018, at over 11%? With a closing price of $18.22, it had a dividend yield of 11.68% and was trading at a P/E of 8.25 (for an earnings yield of 12.12%). With the dividend yield just below the earnings yield, the dividend payout ratio was 96%.

CenturyLink’s dividend payout may be unsustainable because it was nearly equal to its EPS over the previous year. With this in mind, an investor looking for a stock with a high degree of dividend sustainability might have been better off choosing Procter & Gamble as an investment.

What Is the Difference Between EPS and P/E Ratio?

The price-to-earnings (P/E) ratio helps assess stock valuation. Earnings per share (EPS) provides insights into a company’s profitability. Both are tools that investors use to evaluate potential investments.

Is Earnings Yield the Same as EPS?

No, earnings yield is not the same as earnings per share (EPS). While they’re both metrics investors use to evaluate a company, earnings yield measures the earnings per share (EPS) that a company generates for each dollar invested into its shares. EPS indicates how much money a company makes for each share of its stock. EPS is an input required to calculate the earnings yield metric. Earnings yield is calculated by dividing the earnings per share (EPS) in the trailing twelve months (TTM) by the latest closing market share price.

What Is the Difference Between Bond Yield and P/E Ratio?

Bond yield is simply the current yield on a bond. The price-to-earnings (P/E) ratio reveals if a stock is overvalued or undervalued relative to its earnings. The P/E ratio is calculated by dividing the price of a stock by the company’s annual earnings per share (EPS).

The Bottom Line

While the EPS, the P/E ratio, and earnings yield are all related to measuring a company’s profitability, EPS represents a company’s profit per share, the P/E ratio measures how much investors are paying for each dollar of earnings (by dividing stock price by EPS), and earnings yield—the inverse of the P/E ratio—reveals how much earnings a company generates for each dollar invested in its stock. While all of these metrics are useful for understanding a company’s profitability, when evaluating potential returns—especially across different instruments—earnings yield can generate important insights.