Are you a ticker addict? If so, you aren't alone. Most investors look at their stocks at least a few times a week. To immunize myself from ticker temptation I focus on earnings yield and not on price. Earnings yield is the inverse of the widely quoted price-to-earnings ratio. For example, a P/E ratio of 5 is equivalent to an earnings yield of 1/5 or 20%.
I tend to become unhappy when a stock's earnings yield decreases which is often caused by rising prices. Don't get me wrong, capital gains are good but I want to avoid falling in love with stocks that no longer represent good value. An earnings yield focus helps me to sell high and buy low.
The application of an earnings yield approach is best demonstrated with the aid of the ABC Fundamental-Value fund's portfolio. Each stock in the portfolio is shown along with its earnings yield and dividend yield in Table 1. When looking at a whole portfolio it is important to calculate the earnings contribution of each stock (See Table 2). Market Value is found by multiplying the stock's price-per-share by the number of shares held. Earnings are found by multiplying the stock's earnings yield by its market value and dividends by multiplying the stock's dividend yield by its market value.
For instance, Laurentian Bank has a market value of 200,000 times $27.00 or $5,400,000. The bank contributes $725,806 ($5,400,000 times 0.134) in earnings and $216,000 ($5,400,000 times 0.04) in dividends.
All this work allows for the calculation of a portfolio's yield. In this case, the ABC Fundamental-Value fund has an earnings yield of 7.7% and a dividend yield of 1.9%. This is quite good when compared to the TSE 300 which has an earnings yield of only 4.2% and pays a dividend of 1.5%.
Fund portfolios are often a good source of stock picking ideas and the ABC Fundamental-Value fund is better than most. I particularly like stocks that have an earnings yield of more than 10%, a debt-to-equity ratio of less than 1 and a dividend pay-out ratio of less than 50%. Table 3 shows which ABC holdings pass this test. In fact, I like some of them enough to own them. If you want to know which ones just email me and I'll send you the details.
As an active fund, ABC's holdings aren't static. In his latest monthly report, portfolio manager Irwin Michael indicates that Hudson's Bay and Ketch Energy were sold and that Promax Energy and MFP Financial were added to the portfolio. It's likely that there will be more changes by the time this article is published. So, be sure to check out www.valueinvestigator.com for more information on the fund's holdings.
Looking at earnings yield instead of price helps to more properly value stocks and provides a useful measure of performance. Although earnings yield isn't guaranteed it is helpful when comparing bonds to stocks. After all, do you want to hold a guaranteed 6% government bond or a risky stock with an earnings yield of 6%? How about the TSE 300 with an earnings yield of only 4.2%?
First published in June 2001.
|Disclaimers: Consult with a qualified investment adviser before trading. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, financial advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. More...