Finding Value: Determining The Equity Bond Rate From Shareholder Yields

Self-directed stock investors can and should measure shareholder yields beyond just dividends. When researching stocks for inclusion in my family portfolio I consider a company's returns to shareholders as a leading barometer of the worthiness of owning a slice of that business.

I measure the average of the sum of yields per share on trailing earnings, free cash flow, and dividends and then weigh against the 10-year Treasury rate.

The proprietary equity bond rate modeling gives me a sense of whether a stock is worthy of the assumed higher risk profile compared to the allegedly safer intermediate-term government issue.

Here is an alternative methodology to confirm whether your stocks’ shareholder yields are collectively exceeding the 10-year Treasury rate without the limitations of the dividend growth strategy or the risks of high yield dividend investing.

Shareholder Yields as the Equity Bond Rate

A simple definition of a stock's equity bond rate is how its yields compare to the rates of government-issued bonds. Dividend yields are the typical comp, but I also use two other metrics to measure a stock's current return to shareholders.

Earnings Yield

Earnings yield is the annualized trailing GAAP earnings per share divided by the most recent stock closing price. I view earnings yield, the inverse of the price to earnings ratio as the equivalent of a stock's equity bond rate or how a company's earnings compare to the 10-year Treasury rate, which was yielding 2.75% as of this writing.

Thus, I am looking for stocks with earnings yields exceeding 5% or at least 225 basis points (two and a quarter percentage points) above the current 10-year Treasury yield. Targeting earnings yields above 5% is the equivalent of price to earnings ratios below 20 times.

Naturally, the higher the earnings yield (and lower the P/E ratio), the more out of favor the stock appears with Mr. Market. Nevertheless, as a value investor, quality enterprises with high earnings yields get my attention for further research.

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Disclosure:  My family portfolio is long AEO, DKS, and KSS.

Copyright 2019 by David J. Waldron. All rights reserved, worldwide.


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