While the price-to-earnings ratio is perhaps the most common valuation metric, the reverse of the ratio is another way to gauge valuations. Called the earnings yield, this is calculated by dividing earnings by price rather than the other way around which would result in the P/E ratio. In the Valuation Section of our Annual Outlook Report released last week, we took a look at the S&P 500’s earnings yield relative to corporate bonds. An excerpt is below. To view the entire section and gain access to all of the other sections (plus the rest of our research offering), join Bespoke Premium with this 2020 special offer.
Comparing the earnings yield of the S&P 500 to the yield on the 10-Year US Treasury (a so-called risk-free asset) has the potential to be an apples to oranges comparison as stocks are considered a risk asset and treasuries are considered a ‘risk-free’ rate of return. To help take that into account, the chart below compares the earnings yield on the S&P 500 to the yield on corporate bonds using the average yield of Moody’s AAA and BAA corporate indices.
The earnings yield of the S&P 500 relative to corporate bond yields is currently right inline with its historical average. Looking back at this relationship over time, pre-1960 this ratio was much higher than average. Then, it was much lower than average for the next 50 years. In the last decade now, the ratio has stayed pretty close to its historical average. Not too hot. Not too cold.