If you are unsure about whether to invest your money in stocks or bonds, one important financial parameter that can show you the right direction is earnings yield. It is the inverse of the price-to-earnings (P/E) ratio and can be used for identifying undervalued stocks. In addition to this, the ratio is also very useful for comparing stocks with the market or fixed income securities.
Earnings Yield can be calculated as (Annual Earnings per Share/Market Price) x 100. While comparing similar stocks, the one which gives high earnings yield should provide better returns.
This ratio also comes in handy for comparing the performance of a market with the 10-year Treasury yield. When the yield of the market index exceeds the 10-year Treasury yield, stocks can be regarded as undervalued in comparison to bonds. This implies that investing in the stock market is a better choice for a value investor.
However, while T-bills are free of risks, investing in stocks always comes with a caveat. Hence, it would be wise to add a risk premium to the Treasury yield while making a comparison with the earnings yield of a stock or the broader market.
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 19 stocks that made it through the screen:
Wilmington, DE-based The Chemours Company (CC – Free Report) is engaged in the chemical business. It has a Zacks Rank #1 and an expected EPS growth rate of 15.5% for the next 3–5 years.
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