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Chapter 20

3.2 Earnings yield method

The earnings yield is the inverse of the PE ratio, hence:

Value per share = EPS × 1/earnings yield

Total value of equity = Total earnings × 1/earnings yield

Incorporating constant growth in earnings:

Total value of equity = earnings × (1 + g)

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earnings yield – g

Question 3

Earnings yield valuation

Company J has earnings of $1.2 million. A similar listed company has an
earnings yield of 11%. J’s earnings have been growing at a rate of 2% per
annum but it is unknown as to whether this will continue.

Estimate the value of J Co in the situation of no growth in earnings and of
growth maintained at 2% per annum.

Without growth, value = earnings × 1/earnings yield

Value = £1.2m × 1/0.11 = $10.9 million

With 2% growth, value = (earnings × (1 + growth))/(earnings yield – growth)

Value = ($1.2m × 1.02)/(0.11 – 0.02) = $13.6 million

Illustrations and further practice

Now try TYU question 3 from Chapter 20.

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