Earnings Yield

From Dr. Ed Yardeni's Blog.  Chart shows the long term trends in earnings yield.  Earnings yield is one of the key metrics we use in our valuation metrics.  Earnings yield is the inverse of the price earnings ratio.  That is, it is the earnings divided by the price of the security in question.  The justification for using this tool is that investors often substitute earnings for dividends as theoretically earnings can be plowed back into the company being evaluated.  

While I'm just eyeballing this, I think it's fair to say that the average earnings yield on the S&P 500 has more or less traded in the 6-8% range in the past 35 years.  Yields underneath these levels are indicative of over priced markets while yields exceeding this range indicate stocks are undervalued.  Looking at the earnings yield from 2009 onwards shows that until last year stocks for the most part traded above this long term range, indicating that stocks were cheap.  The subsequent rallies during that time proved that analysis correct.  From 1997-2001, according to this chart, stocks were overvalued by this analysis and we all know how that ultimately turned out.  However, it should be noted that stocks had an incredible run through most of that period, showing that stocks can stay overvalued much longer than many investors believe possible.

The current earnings yield is about 6.4 for this year.  That is in the lower level of that 6-8% range and implies that stocks may be in the short term a bit ahead of themselves but the not out of line with historic norms.  

Link:  Yardeni:  "Fed Model, Buybacks and M&A".

*Long ETFs related to the S&P 500 in client and personal accounts, although positions can change at any time.