Rimmi Singhi
5 min read
The U.S. economy is entering a more challenging environment as renewed Middle East tensions push oil prices above $100 a barrel, adding to inflationary pressures. Annual CPI inflation accelerated to 3.4% in August, well above the Federal Reserve’s 2% target. Meanwhile, a stronger-than-expected jobs report and hawkish comments from Fed Chair Kevin Warsh have increased expectations for a 25-basis-point rate hike tomorrow—the first in more than three years.
With borrowing costs already weighing on financially stretched households, higher rates could further pressure economic activity and create a more selective environment for investors. Against this backdrop, value investing could offer a compelling approach.
Value investing means buying stocks that are priced below what they are really worth. It works on the idea that markets often misprice stocks, giving investors a chance to buy low and profit later. Ternium S.A. TX, Halozyme Therapeutics HALO, POSCO Holdings Inc. PKX and Talos Energy LLC TALO are a few solid high-value picks with high earnings yields.
Earnings Yield Strength
Earnings yield is useful for investors concerned about the rate of return on investment. This metric, expressed as a percentage, is calculated as annual earnings per share (EPS) divided by market price. This metric measures the anticipated yield (or return) from earnings for each dollar invested in a stock today. While comparing stocks, if other factors are similar, the ones with higher earnings yield are considered undervalued, while those with lower earnings yield are seen as overpriced.
While earnings yield is nothing but the reciprocal of the P/E ratio, it is a little more illuminating than the traditional P/E ratio, as it also facilitates the comparison of stocks with fixed-income securities. Investors often compare the earnings yield of a stock to the prevailing interest rates, such as the current 10-year Treasury yield, to get a sense of the return on investment it offers compared to virtually risk-free returns.
If the yield on a stock is lower than the 10-year Treasury yield, it would be considered overvalued relative to bonds. Conversely, if the yield on the stock is higher, it would be considered undervalued. In this situation, investing in the stock market would be a better option for a value investor.
The Winning Strategy
We have set an 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:
