Earnings Yield Metric vs Discounted Cash Flow Analysis.
What Is Earnings Yield?
The earnings yield refers to the earnings per share for the most recent 12-month period divided by the current market price per share. The earnings yield (the inverse of the P/E ratio) shows the percentage of a company's earnings per share.
Earnings yield is used by many investment managers to determine optimal asset allocations and is used by investors to determine which assets seem underpriced or overpriced.
Earnings yield is one indication of value; a low ratio may indicate an overvalued stock, or a high value may indicate an undervalued stock.
The growth prospects for a company are a critical consideration when using earnings yield. Stocks with high growth potential are typically valued higher and may have a low earnings yield even as their stock price rises.
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What Is Intrinsic Value?
Intrinsic value is a measure of what an asset is worth. This measure is arrived at by means of an objective calculation or complex financial model, rather than using the currently trading market price of that asset.
In financial analysis this term is used in conjunction with the work of identifying, as nearly as possible, the underlying value of a company and its cash flow.
Discounted Cash Flow and Intrinsic Value.
The discounted cash flow (DCF) model is a commonly used valuation method to determine a company's intrinsic value. The DCF model uses a company's free cash flow and the weighted average cost of capital (WACC). WACC accounts for the time value of money and then discounts all its future cash flow back to the present day.
The weighted-average cost of capital is the expected rate of return that investors want to earn that's above the company's cost of capital. A company raises capital funding by issuing debt such as bonds and equity or stock shares. The DCF model also estimates the future revenue streams that might be received from a project or investment in a company. Ideally, the rate of return and intrinsic value should be above the company's cost of capital.
The future cash flows are discounted meaning the risk-free rate of return that could be earned instead of pursuing the project or investment is factored into the equation. In other words, the return on the investment must be greater than the risk-free rate. Otherwise, the project wouldn't be worth pursuing since there might be a risk of a loss.
Intrinsic value is a core concept of value investors seeking to uncover hidden investment opportunities.
Basically, Yield Metric values based on share price and Discounted Cash Flow values based on what the company is actually worth.
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Understanding Accidental High Yielder.
An accidental high yielder is a company that pays a high dividend yield, even though this was not management's original intention. The high yield is the result of a steep decline in the company's stock price. The dividend remains the same though the stock price has dropped, resulting in a historically higher yield.
Accidental high yielders often occur in bear markets, when stock prices decline.
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From my perspective, many accidental high yielder's that see stock prices decline is the result of the market correcting for one reason or another. Nothing has changed within the company, in fact earnings growth continues to show strength. Other high yielder's have high yields due to prices falling because the company is underperforming.
Under the current condition of the market, geopolitical issues, inflation and expected higher interest rates, I think the market is justified in correcting but what I am looking for is companies that are accidental high yielders due to the market correcting, not because of weakening company fundamentals. I'm looking at companies that under current market conditions, show double digit earnings growth expectations.
It is under this scenario that I am using the DCF Model to establish a company's intrinsic value (true worth) and not falling slave to market prices.
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