In the financial world, yield is expressed as a percentage and it mostly refers to the annual income as a proportion of the current price of the asset. In the property market, there is the rental yield. In the bond market, there is yield to maturity. In the share market, there is the dividend yield. Then there is also the earnings yield.
An earnings yield of a company’s shares measures the after-tax profit per share as a percentage of the share price. It is the inverse of the price-earnings ratio.
FAANG shares have been market favourites in recent years, a reflection of their dominant digital technology. The companies are Facebook, Apple, Amazon, Netflix and Google parent Alphabet. These five companies in aggregate represent 12% of the market value of the S&P 500 index. Their share prices are a reflection of the market’s view their growth rates will be sustained. All these companies are trading at high price-earnings ratios and thus low earnings yields. Low earnings yields combined with a low-interest-rate environment means these companies can raise capital on very attractive terms.
With such a low cost of capital, acquisitions by these companies do not have to meet demanding hurdle rates of returns and the prospect of a misallocation of capital emerges. However, a company with a low earnings yield which acquires a company with a marginally higher earnings yield will immediately have a boost to its earnings per share. Should the acquisition not deliver the expected outcome the share price will be revalued; the earnings yield will rise and the share price will fall.