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Warning: Market Valuations have Run Up

Earning yield of Sensex over the years has declined recently with rising market, which might be a warning sign for investors

Earnings Yield is an increasingly rare way of looking at a potential investment. Preferred by Benjamin Graham, Buffett’s guru and the father of value investing, Earnings Yield is calculated by dividing the net profit by the market capitalisation. Look at it another way: Earnings Yield is the inverse of the more commonly used PE ratio but Earnings Yield gives much more usable information. It shows what return you make on an investment at its current price. In this way you can compare a stock’s or the market’s earnings yield with a risk-free return or the fixed deposit rate. An Earnings Yield higher than the risk-free return is more attractive, valuation-wise.

The chart (above) shows the earning yield of Sensex over the years has declined recently with rising market. The bar graph (below) shows the number of companies (as a per cent of total) in BSE-500 companies which had earnings yield of more than nine per cent, the current FD rate. It is startling that only 15 per cent of the companies have earnings yield of more than nine per cent - the lowest figure in the past five years. This tells that market valuations have run-up. A warning sign for takers?