Investors often use P/E ratio and other valuation metrics while picking undervalued stocks with solid upside potential. However, it is difficult to use the P/E ratio to compare stocks with fixed income securities. This is where earnings yield comes handy.
Earnings yield is calculated as (Annual Earnings per Share/Market Price) x 100. In other words, it is the inverse of P/E ratio.
Other things remaining constant, a stock with higher earnings yield has the potential to provide comparatively greater returns. This metric is also used to compare the performance of a market index with the 10-year Treasury yield as well.
For instance, if the yield of the market index is more than the 10-year Treasury, stocks can be considered as undervalued in comparison to bonds. In such a case, investing in the stock market would be a better option for a value investor. However, given the risk-free nature of T-bills, it would be prudent to add a risk premium to their yield while comparing with a stock or the market index.
The Winning Strategy
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 to generate 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.
Here are four of the 11 stocks that made it through the screen:
Teck Resources Limited TECK is a diversified resource company committed to responsible mining and mineral development with major business units focused on copper, metallurgical coal, zinc, gold and energy. The company carries a Zacks Rank #1 and its expected EPS growth rate for the next 3–5 years is 10.7%.
Cosan Limited CZZ was established as the controlling shareholder of Cosan S.A., a Brazilian company, after the corporate restructuring of the Cosan Group in Brazil. Cosan Limited currently holds roughly 62.3% of the controlling shares of Cosan S.A., which is engaged in the cultivation, harvesting and processing of sugarcane. This Zacks Rank #1 company has an expected EPS growth rate of 16.3% for the next 3–5 years. You can see the complete list of today’s Zacks #1 Rank stocks here.