From: fool@motleyfool.com
To: benjamin.rogers@enron.com
Date: 2000-11-08 15:16:00+00:00
Subject: Investing Basics: The Earnings Yield

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                   I N V E S T I N G  B A S I C S
                     Wednesday, November 8, 2000

benjamin.rogers@enron.com
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INVESTING BASICS - THE EARNINGS YIELD

One way to think about what you're paying for a company is to
consider its price-to-earnings ratio, or "P/E." Another way is
to calculate its inverse, which is its "earnings yield."

Consider the example of Fryyndar and Ulf Scandinavian
Pharmaceuticals (ticker: FANDU), whose motto is "Vars+god och
sv,lj!" (That's Swedish for "Here, swallow this pill!") To
calculate its P/E ratio, you simply divide the current stock
price by the annual earnings per share (EPS). If its current
annual EPS is $3 and the stock is trading for $111 per share,
the P/E is $111 divided by $3, or 37. While 37 might seem steep,
it's not meaningful until you compare it with the P/E ratios of
industry peers and consider its growth prospects. A high P/E
means the market is assuming rapid growth. (Is that assumption
reasonable?)

To calculate Fryyndar and Ulf's earnings yield, just reverse the
P/E ratio, dividing the annual EPS by the current stock price.
$3 divided by $111 equals 0.027, or 2.7 percent. Compared to
risk-free Treasury bond rates of roughly 5 percent, this doesn't
appear to be a bargain. But remember: Whereas bond rates are
fixed, earnings typically grow. Imagine that FANDU is expected
to increase earnings by 10 percent per year. If so, in 10 years
EPS should grow to $7.78. Assuming we bought shares when they
were at $111, the earnings yield for us has now become 7
percent, considerably better. ($7.78 divided by $111 is 0.07.)

It can be instructive to see how long it takes for the growing
earnings yield to pass the current 30-year bond rate, which is
now about 5.5 percent. FANDU passes it in six years.

If your desired rate of return on your invested dollars is 15
percent, it will take FANDU 18 years to reach that target -- if
earnings actually grow at the estimated pace, that is. Perhaps
you can find another investment that will get you there more
quickly. With riskier companies, you might look for them to pass
your target rate sooner rather than later.

The earnings yield is just one of many investor tools. It can
help you think more effectively about your expectations for
investments.
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A NOTE FROM THE AUTHOR(

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