Is Earnings Yield a Security Return Model Anomaly?

Abstract

This paper supplements the traditional security return model, by adding earnings yield to the risk-free rate, market risk, size, and book-to-market equity as predictors of security returns. Earnings yield is the ratio of net income to market price, so that it represents the segment of market price that depends upon operating performance of the firm, rather than market perception. This paper establishes a theoretical framework for the earnings yield construct, describing it as a predictor of return on assets, return on equity, economic value added, and the equity multiplier. Earnings yield, therefore, predicts the ability to purchase productive assets, achieve a positive return for shareholders, and increase debt capacity. Then, earnings yield is subjected to empirical testing through a regression of its impact on security returns, with the finding that it explained a significant amount of the variance in security returns beyond size and book-to-market equity.