Earnings Yield | Investing Glossary

What it is

Earnings yield is simply the P/E ratio flipped upside down. If a stock has a P/E of 15, its earnings yield is 1/15 = 6.7%. It expresses the same information differently: instead of asking "how much am I paying per pound of earnings?", it asks "what percentage return am I getting in earnings per pound I invest?"

The reason this reframing matters is that it puts equities and bonds on the same scale. A UK government gilt yielding 4.2% and a stock with an earnings yield of 6.7% can now be directly compared — at least in theory.

How to calculate it

**Earnings Yield = Earnings Per Share ÷ Share Price × 100**

Or equivalently: Earnings Yield = 1 ÷ P/E Ratio × 100

Use the same EPS as you would for the P/E: trailing twelve months (TTM) for a backward-looking view, or forward consensus for a forward-looking view.

The bond comparison

This is where earnings yield becomes genuinely useful for assessing market valuations in aggregate.

The equity risk premium (ERP) is the earnings yield of the equity market minus the risk-free rate (typically the ten-year government bond yield). The ERP represents the additional return investors demand for taking on the risk of owning equities versus the certainty of a government bond.

Historically, the ERP for UK equities has averaged around 3–4%. If the FTSE 100 has an earnings yield of 7% and ten-year gilts yield 4.2%, the implied ERP is 2.8% — below the historical average, suggesting modest overvaluation relative to bonds (or that rates are expected to fall). If gilts yield 1% and the FTSE earnings yield is 7%, the ERP is 6% — historically indicating that equities are cheap relative to bonds.

This framework — sometimes called the Fed Model (despite being formulated before the Federal Reserve existed in its current form) — is imperfect but directionally useful for assessing the relative attractiveness of equities versus fixed income.

The free cash flow yield variant

Many experienced UK fund managers prefer FCF yield to earnings yield:

**FCF Yield = Free Cash Flow Per Share ÷ Share Price × 100**

This substitutes free cash flow for earnings in the numerator, giving a cash-based measure that is harder to manipulate and more directly relevant to what the business can actually return to shareholders. A stock with an FCF yield of 7% is generating 7p of real cash for every £1 of market value — and that cash can fund dividends, buybacks, or debt repayment.

UK value managers like Anthony Bolton (Fidelity Special Situations) and the Liontrust Special Situations team have historically used FCF yield as a key screen for identifying undervalued UK companies.

Using it in practice

For individual stocks, an earnings yield materially above the long-run average for that sector — combined with a reason to believe earnings are sustainable — can signal potential undervaluation. Conversely, an earnings yield compressed well below the sector norm, with no obvious earnings growth catalyst, suggests limited margin of safety.

FCF yield above 6–8% for a high-quality business is generally considered the zone where long-term-oriented investors become interested. Above 10% on a clean, conservatively accounted basis is where deep value investors tend to get quite excited.

**Practical note:** When interest rates are high — as in 2023–2025 with UK base rates above 5% — the hurdle rate for equity earnings yields rises. A 5% earnings yield on a stock looks much less attractive when cash in the bank pays 5%. The relative value framework shifts meaningfully as rates change.

Not financial advice. Earnings yield is one of many inputs into equity valuation.