How much does a dollar invested in the stock market buy in corporate earnings these days? The short answer is: a lot less than it used to. In fact, the accompanying chart of the trailing 12-month earnings yield of the Toronto Stock Exchange 300 Index shows that it buys you less than zero. Total earnings for TSE 300 companies, after extraordinary items and write-offs, have been negative since last August.
Value investors often look at the price-to-earnings ratio (P/E), which tells you how much investors are paying for a dollar of earnings. The earnings yield is the inverse, or E/P. It tells you, in percentage terms, how much in earnings a company or index is generating per dollar invested. You can compare that return to those of other investments.
The chart shows monthly averages of the TSE 300's earnings yield dating back to 1977. Inflation was high in the late 1970s, and earnings yields hovered around 12%. Central bankers then raised interest rates, which squeezed the economy and corporate earnings, and the earnings yield declined to 4%. The economy recovered in the mid-'80s, dipped into a recession in the early 1990s, then bounced back again.
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The long-term trend in earnings yield is down. Investors are paying more for less. Moreover, the telecom-led decline of the TSE 300 in 2000 and 2001, and the sharp dip after last Sept. 11, has had remarkably little impact. Stock prices declined, but earnings declined even more, so the earnings yield kept going down. The TSE 300 then climbed sharply in late 2001 and in the first quarter of this year. Given the continued dearth of earnings, you have to ask why.