Chartered Financial Analyst (CFA) Practice Exam Level 2

How is earnings yield (EY) calculated?

1. EY = Total Assets / Total Shares

2. EY = EPS / (Share Price)

3. EY = (Dividends paid / Earnings)

4. EY = (Price Earnings Ratio) / EPS

The correct answer is: EY = EPS / (Share Price)

Earnings yield (EY) is a critical metric used to assess the relative attractiveness of an investment, and it is calculated using the formula EY = EPS / Share Price. This calculation helps investors understand how much earnings they are receiving for each dollar invested in the stock. Breaking down the components, EPS (Earnings Per Share) reflects the company's profitability on a per-share basis, while the share price represents the market value of a single share of the company's stock. By dividing EPS by the share price, investors can obtain the earnings yield, which is expressed as a percentage, allowing for easier comparisons with other investment opportunities, such as bonds or alternative stocks. This makes the earnings yield a valuable tool for investors seeking to determine if a stock is overvalued or undervalued relative to its earnings. In contrast, the other formulas provided do not accurately describe the calculation of earnings yield, as they refer to different financial metrics or relationships. For example, the total assets to total shares ratio does not take earnings into account, while dividends paid does not reflect the share price or earnings specific to the share. The Price Earnings Ratio divided by EPS also does not lead to a clear measurement of earnings yield and misrepresents the relationship intended.