One of my favorite metrics in evaluating a business is the earnings yield. This simple calculation divides the after-tax earnings of a company by the market capitalization. Let’s say you buy a business for $1MM and you earn $100,000 this year after-tax, the earnings yield would be 10%. This is the inverse of the price to earnings ratio, so the P/E on this business at the $1MM purchase price would be 10x. Some companies deserve to trade at far higher valuations than other companies. For instance, if the company is likely to grow robustly for the next 10 years or so, a 20-30x multiple might be reasonable. However, if the company’s earnings are likely to decline rapidly, or even turn into losses, even a 10x P/E might be too high. At T&T Capital Management, we like to find businesses trading with very high earnings yields, that also have strong growth prospects. Often the most glamorous industries such as AI today, get overpriced, leading to bubbles. Other less popular sectors also have growth, but they are priced like bargains, so finding those securities generally leads to higher long-term returns, and this is really what value investing is all about.
In this article, we are going to look at the current earnings yields of some of the more popular and highest concentrated positions in the S&P 500. Remember, the earnings yield reflects the payout a company would provide you with if you bought it at today’s valuation, and it paid 100% of its earnings as a cash dividend:
Nvidia: 1.33%
Tesla: 1.53%
Amazon: 1.78%
Netflix: 2.08%
Microsoft: 2.5%
Apple: 2.85%
Meta: 3.22%
Google: 3.44%
S&P 500: 3.44%
As you can see, all of these stocks and the index have earnings yields well below 3.5%, even with Treasuries bonds trading around 4.3%. Some of these stocks deserve to trade at higher multiples, but others are barely growing. Even the super high growth stocks such as Nvidia, are extremely challenging to forecast earnings for over the next 3-5 years, due to the historically high margins and cyclical demand we currently see. How sustainable that is not an easy call whatsoever!
On the value side there are still some compelling bargains. For real estate investment trusts such as Vici or W.P. Carey, we use FFO/Price, which offers a similar perspective as P/E adjusted for differences in accounting for real estate:
Citigroup: 9.2%
BNP Paribas: 14.3%
VICI: 9%
WPC: 8.65%
CCI: 7%
APA: 15.4%
DVN: 11.26%
While these companies might not be as popular as the first group, they all should see pretty solid earnings growth over the next 5-10 years, but they are priced as though they will not grow. They also pay dramatically higher dividends than the first group. We are only looking at earnings yields and there are many other data points, both objective, and subjective, that we look at to make investment decisions. The point of this is just to give some brief insight into how we take a business-like approach to investing, and to show some of the dramatic disparities in current valuations.