Earnings yield is perhaps one of the most widely used metrics when determining overall market valuation. That's because it provides an easy and revealing way to look at the current valuation of stocks -- and to compare them to bonds, which compete with stocks for investors' capital.
So investors should pay attention to stock and bond yields, because the relationship between the two can be particularly revealing. The higher the yield on stocks is, the more attractive they are -- or, to put another way, the more undervalued they are. So if the earnings yield on stocks is higher than yields on bonds, stocks are considered more desirable (i.e., more undervalued) vs. bonds -- and vice versa.
At the end of 2011, the S&P 500 was at 1257.60 and the projection for 2011 average earnings from S&P stocks was $97. That translates into a year-end earnings yield of 7.7%. At the same time, government bond yields range between 0% and a bit over 3%, with 10-year Treasuries -- most widely used as a comparison -- coming in at 1.93%. That big of a difference hasn't been seen since the early 1990s, according to my data, and it indicates we may truly be seeing a historic buying opportunity for long-term investors.
Earnings yield isn't the only metric that's flashing a long-term buy signal. Bespoke Investment Group has also found stocks to be undervalued, according to CNBC.com. At the start of 2012, S&P 500 stocks traded at an average price-to-earnings multiple of 13x -- below the 80-year average of 15x, and lower than at any time since 1990.
Average price-to-book ratio came to 2.05 for S&P shares, well below the 2.43 P/B average since the late 1970s. Dividend yield was also higher than the 10-year Treasury yield. Outside of the credit-crisis period, this hasn't happened since prior to 1960, according to Bespoke.
Given that the overall market currently looks attractive by the earnings-yield metric, I thought it might be interesting to screen for some stocks that look even more attractive than average. To do that, I turned to my computerized strategy based on Joel Greenblatt, which uses only two variables: earnings yield and return on total capital.
Greenblatt calculates earnings yield by dividing a company's earnings before interest and taxes by its enterprise value, which includes not only the price of the company's shares, but also the amount of debt it uses to generate earnings. In this regard, Greenblatt is really measuring how much of a return, or yield, you could expect if you bought the entire business, including all of its debt.
Expedia (EXPE), one of the largest online travel sites is one example of a company with a high earnings yield: The number comes in at 16.93%, or No. 83 in our database. The 24th-ranked company, meanwhile, is GameStop (GME), the world's largest video-game retailer. GameStop's yield is a healthy 23.08%. Coming in at No. 6, with a robust 38.53% earnings yield, is ASM International (ASMI), a Netherlands-based semiconductor-equipment maker.
Also earnings top marks are Aeropostale (ARO) and Capella Education (CPLA). Aeropostale, a major teen-apparel retailer, sports an earnings yield is 20.50%, ranking it No. 40. Capella -- an exclusively online university with more than 35,000 students -- comes in at No. 37 with earnings yield of 21.03%.
When looking at bond and stock yields, this looks like a potentially great long-term buying opportunity, and searching from the highest earnings yields in the market could be a great place to start. These are five companies that fit the bill.