Mental Models discussed in this podcast:
- Earnings Yield
- Discount Rate
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You can find out more information by listening to episode 11 of this podcast.
Earnings Yield on Cost
- In our last episode, we discussed the source of investment returns. In this episode, we’ll dive deeper into the nuance of stock valuation.
- A rule of thumb is a simple reference point method to quickly determine whether a stock is overvalued or undervalued. A rule of thumb for valuation is not a substitute for valuation, but simply a starting point to allow you to focus and prioritize your time on ideas that appear to be good values.
- Earnings Yield – Current Earnings / Stock Price
- Earnings Yield on Cost: Possible Future Earnings / Original Stock Purchase Price
- Rule of thumb: Earnings yield on cost must eventually exceed 10% in order to earn a 10% rate of return on your investment (due to business performance) versus speculation.
Investing Rule – Earnings Yield and Discount Rate
Stocks must eventually trade at an earnings yield on cost equal to your discount rate in order to earn your required return on capital for you as an investor.
Stock Investing Examples
- $1.22T Market Cap
- 2019 Earnings: $11.5B
- Earnings Yield: 0.9%
- $1.38T Market Cap
- 2019 Earnings: $55B
- Earnings Yield: 3.9%
- Discover Financial
- $14.5B Market Cap:
- 2019 Earnings: $2.9B
- Earnings Yield: 20%
- $184m Market Cap
- 2019 Earnings: $39m
- Earnings Yield: 21.2%