November 10, 2021

Inflation-Adjusted Earnings Yield




Rick Bookstaber

Co-Founder and Head of Risk
















If you are both valuation-focused and inflation-aware, equity prices are out of this world.



The usual measures are not too great. Here is a chart showing the median price vs. sales (top) and price vs. operating earnings (bottom) for the S&P 500. Both at or near record highs. Any number of other valuation measures are at historic highs. Market cap vs. GDP as one example.

Price To Operating Earnings Ratio and P to S

Bad enough, but if  we adjust earnings for inflation to look at real earnings, we are in uncharted territory. This chart shows smoothed inflation-adjusted earnings yield.

SP 500 Real Earnings GAAP Yield without Title


It is below the 2000 and 2008 levels, even below the worst levels during the 1970's, when there was a huge inflation tailwind.

The counterargument is that with low rates, discounted future earnings count for more. But as I have argued elsewhere, this Finance 101 approach to valuation works for a class assignment, but not for serious valuation. The risk premium on earnings looking out 20 years is going to dominate the effects of an interest rate that is a percent or so lower than the recent past.

Thanks to Ned Davis for highlighting the real earnings yield.