Earnings Yield EY

WHY
WE SHOULD STOP USING

PRICE EARNINGS (PE) RATIO
SUSHEEL NARULA
SUSHEELN@GMAIL.COM
2022
ISSUE: This paper questions a common approach undertaken by most sell-side
analysts that not enough diligence goes into the ‘valuation-process’. Most
KEY POINTS assessments of fair stock prices (or target prices) are made by multiplying projected
earnings with a multiple (PE Ratio), often derived from the past without relating its
historical context to the current environment.
PROPOSED SOLUTION: This paper proposes to use Earnings Yield (EY, an inverse of the
PE Ratio) to replace current practice. The proposed approach offers insights and a
rich context that should lead to less error.
BENEFITS OF EY: EY allows us to divide risks into different components which enable a
greater understanding of the relationships between the macro-economy, risk
appetite and company business. Better knowledge of market dynamics should
improve investment skills and make the monitoring process more enjoyable.
SCOPE: This analysis presented in this report deals with the Thai equity market (the
SET Index). But its implications could apply to other developing markets as well.
2022 susheeln@gmail.com 2
SET Earnings
Price / EPS
Date Index Per Share *
(PE Ratio)
(Price) (EPS)
CHANGE IN PE RATIO
(OR MULTIPLE) HAS

DEC 2010 1,033 83.3 12.4
BEEN THE MAIN

DEC 2021 1,658 94.8 17.4
DRIVER OF THE
CHANGE 61% 14% 41%
SET INDEX
Note: All Earnings Per Share (EPS), and related terms used in this report, including PE Ratio and Earnings
Yields, are based on 12-month rolling consensus estimates from Bloomberg.
GDP Growth
12%
MAJOR EXPANSION OF 10%
8%
PE RATIO OCCURRED 6%
IN THE LAST CYCLE 4%
2%
CYCLE 1 2 0%
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
Period 1999-2009 2010-2020
-2%
Event SUB-PRIME COVID

-4%
Annual GDP Growth 4.3% 2.7% 1 (1999-2009)
-6% 2 (2010-2020)
Annual SET Index Change 15% 8%
-8%
Annual EPS Growth 37% 2%
Average PE Ratio 10 14 -10%
Source: SET, NESDB and GDP forecasts from BOT
WHAT IS PE RATIO (MULTIPLE)?
EXPLANATION EXAMPLE
Stock Price = 20
PE Ratio is a measure of how expensive a stock is. It is derived by dividing stock price by
EPS =2
annual Earnings Per Share (EPS). It is also often referred to as PE Multiple.
PE Ratio =20/2=10
A PE Ratio of 10 means it will take 10 years for earnings to accumulate and be equal to PE Ratio =10
stock price (i.e., achieve breakeven), assuming there is no earnings growth. Years to Breakeven =10
Years to Breakeven =10

PE Ratio has no meaning on its own.
Expensive or Cheap? Can’t say
PE Ratio Stock A = 10, More Attractive

It only has meaning when used to compare with PE Ratios of similar companies (Peers). PE Ratio Stock B = 20, More Expensive
(assume similar growth outlook)
Current PE Ratio at 10 makes the stock

It also has meaning when compared to its trading patterns in the past. appear attractive if its historical average is
20.
PE Ratio is often designated with ‘x’ as its unit. PE Ratio = 10x
PE RATIO HAS BEEN IN USE FOR MORE THAN A CENTURY AND IS THE MOST WIDELY ADOPTED WAY TO VALUE EQUITY.
HOW PE RATIO WORKS
Asset Value. Imagine an asset that pays dividend of 1 Baht every PE Ratio moves inversely to Interest Rate
year without any risk of default. Theoretically, its value would be
40 4.0%
its annual payment divided by the interest rate (discount rate)
SET Index PE Ratio (x) Average Banks Deposit Rate (%)
prevailing at that time.
35 3.5%
Prevailing Interest Rate: For investors, ‘Prevailing Interest Rate’
is either the Banks’ Deposit Rate or Government Bond Yield, 30 3.0%
which is considered free of default risk.
25 2.5%
Asset value at different Interest Rates and their implied PE Ratio

20 2.0%
Price or Value
Interest Rate PE Ratio (x)
of Asset 15 1.5%
10% 1 Baht/10% = 10 Baht 10 Baht / 1 Baht = 10x

10 1.0%
5% 1 Baht/5% = 20 Baht 20 / 1 = 20x

5 0.5%
1% 1 Baht/1% = 100 Baht 100 / 1 =100x

0 0.0%
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Jan-18
Jan-19
Jan-20
Jan-21
0.1% 1 Baht/0.1% = 1,000 Baht 1,000 / 1 = 1,000x
Source: SET, BOT
PE Ratio here is 12-Month Trailing. Both lines based on 12-month rolling averages.
PROFESSIONAL INVESTORS USE LONG-TERM GOVERNMENT
BOND YIELDS TO REPRESENT INTEREST RATES
• A 10-Year government bond duration is generally used as the 10Y TGB Yield SET PE Ratio (x)
long-term benchmark. It is denoted as 10Y TGB (Thai 5.0% 25
Government Bond) Yield here. 10Y TGB (%) SET INDEX PE RATIO (rhs,x)
• 10Y TGB Yield fell from an average of 3.51% in 2010 bottoming at

1.27% average in 2020, and recovered to a 1.74% average in 4.0% 20
2021.
• During this period, the average SET PE Ratio expanded by 60% to
an average of 18.1x in 2021. 3.0% 15
• This inverse relationship underlines human psychology. Lower

Interest Rates encourage risk taking, thus pushing up asset prices.
• The S&P500 index, world’s largest equity market, behaved 2.0% 10
similarly.
S&P500 SET INDEX
Average PE Ratio (x) 10Y UST Yield* PE Ratio (x) 10Y TGB Yield 1.0% 5
2010 13.0 3.19% 11.3 3.51%
2020 20.4 0.89% 16.9 1.27%

0.0% 0
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2021 21.4 1.43% 18.1 1.74%
* UST is United States Treasury, a term used to describe the US government bond.
ESTIMATES OF EFFORTS SPENT ON EQUITY RESEARCH
THIS RELATIONSHIP IS NOT EPS

ESTIMATE
FAIR
FORECASTS
PE RATIO
SUFFICIENTLY REFLECTED IN
TIME SPENT 70-80% 20-30%
THE VALUATION PROCESS
EFFORTS*
REPORT
80-90% 10-20%
CONTENT
IMPACT ON
RESULTS SHARE PRICE
33% 66%
* Numbers related to ‘Time Spent’ and ‘Report Content’ are based on the judgement of the
author. Numbers related to ‘Impact on Share Price’ is quantified on Page 3.
PE RATIO IS OFTEN USED AS IF MARKET
CONDITIONS REMAIN UNCHANGED
ASSUMES THAT PEERS

COMMON WAYS TO ESTIMATE
COMPARE WITH PEERS ARE FAIRLY VALUED IN
FAIR VALUE USING PE RATIO THE FIRST PLACE.
25
20
15 PE RATIO TRENDED
COMPARE WITH THE FROM 10x TO 20x. HOW
PAST LONG BACK TO GO AND
10
COMPARE?
0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
BETTER INSIGHTS POSSIBLE
PRICE / EPS EPS / PRICE
MEASURE
= PE RATIO (x) INVERSE = EARNINGS YIELD (%)
- A relative multiple used to

- A percentage return (yield), similar to deposits, fixed income or
Returns compare with peers or own
dividend yields
history
- Higher multiples associated with - Higher returns generally associated with higher risks
Risks higher risks - Nature of risks and returns can be quantified into the following 3
components.
1. Macro-economic
Risks & Returns 2. Equity Asset Class
3. A particular Stock
INVESTMENT IN STOCKS GIVES COMPENSATION
RISE TO 3 RISK COMPONENTS FOR RISKS
Government Bond Yield

- Government bonds are free of default risk.
1. ECONOMY • Inflation risks - Adjusted for inflation, has risk on ‘real return’.
- 10-Year term is considered long enough to
reflect the long-term nature of stocks.
Equity Risk Premium (ERP)

• Growth pattern - Additional returns investors demand for
2. EQUITY ASSET CLASS exposure to the higher-risk asset class above
• Volatility risks
the 10Y TGB Yield.
- It is also a measure of equity risk appetite.
• Nature of business Beta

- Additional returns investors demand over ERP
• Nature of industry
3. STOCK-SPECIFIC RISK to invest a particular stock.
• Capital structure
- This additional level is described as ‘Beta’.
• Liquidity - It is a multiplier to ERP. If beta is 1, the stock
will require the same risk compensation as the
equity market. If beta is more than 1, the stock
has higher risk than market. If less than 1,
lower risk.
THE 3 COMPONENTS ADD UP TO TOTAL EQUITY RISK
EXPOSURE AND THE FAIR LEVEL OF EXPECTED RETURNS
ECONOMY EQUITY ASSET CLASS STOCK EQUIVALENT

10Y TGB Yield Equity Risk Premium (ERP), est. 4%-5% Beta TOTAL
FAIR PE RATIO IF
FAIR RETURNS
THEIR PRICES =1
EQUITY INDEX 2.0% 5.0%

7.0% 1/7.0% = 14.3x
STOCK A (Beta =1) 2.0% 5.0% 7.0% 1/7.0% = 14.3x
STOCK B (Beta = 1.25) 2.0% 5.0% 1.25%

8.25% 1/8.25% = 12.1x
STOCK C (Beta = 0.8) 2.0% 4.0% 6.0% 1/6% = 16.7X
0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0%
Returns to compensate for inflation risks

Returns to compensate for Equity Asset (ERP)
Returns to compensate for risks associated with a stock over ERP
7.0%
Equity Risk Premium Credit Risk Premium Risk-Free Rate
6.0%
CONCEPT OF EQUITY RISK 5.0%
5.0%
PREMIUM (ERP) IS 4.0%
3.1%
3.0%
SIMILAR TO THAT OF 1.7% 1.7%
2.1%
1.2%
0.8% 0.8%
2.0%
CREDIT RISK PREMIUM

1.0% 1.86% 1.86% 1.86% 1.86% 1.86% 1.86% 1.86% 1.86% 1.86%
FOR CORPORATE BONDS

0.0%
10Y TGB AAA AA+ AA AA- A+ A BBB+ SET Index
Yield
Source: ThaiBMA, as of 20 December 2021. Credit spread based on average duration of more
than 5 years. SET Index Equity Risk Premium is estimated by author.
ERP HAS BEEN RELATIVELY STABLE AND CAN BE
EXPECTED TO REMAIN SO
10%
• Equity Risk Premium (ERP), the additional returns that
9%
10Y TGB Yield (%) SET INDEX ERP (%)
investors expect above the 10Y TGB Yield remains relatively 8%
7%
stable at an average of 4.5% since 2010. In 2021, it averaged
6%
4.0%.
5%
• This is despite 10Y TGB Yield halving its level from about 4% 4%
3%
to less than 2% during this period.
2%
• The fact that ERP does not fluctuate much beyond a certain
1%
band suggests that investors adopt it as a foundation to 0%

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
price equity. 10%

EQUITY RISK PREMIUM (ERP)
• A similar situation is also observed in the S&P500 index. 8%
EQUITY RISK PREMIUM (ERP) 6%

2000-2021
S&P500 Index SET Index
4%
Average 4.2% 4.5%
2%
Standard Deviation 1.0% 0.7% SET Index S&P500 Index
0%
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
BETA IS A FACTOR ASSOCIATED WITH RISKS &
OPPORTUNITIES OF A SPECIFIC STOCK
• Beta measures the sensitivity of how a stock is expected to perform in relation to the equity
index that it is listed in.
• A stock with a beta of;
= 1, stock performance expected to be similar to that of SET Index
<1, stock performance expected to move slower than that of SET Index
>1, stock performance expected to move faster than that of SET Index
• It is calculated by dividing the covariance of returns between the stock and the index (e.g., SET
Index) with the variance of returns of the index (e.g., SET index).
• The information is widely available among brokers and financial platforms.
MORE BENEFITS FROM USING EARNINGS YIELD
Role Analyst Economist Strategist Analyst
÷ Fair Risk Free Equity Risk

EPS Fair EY Beta of a
Earnings Rate (10Y Premium
Estimate from > stock
Yield (EY) TGB Yield) (SET Index)
• More objective assessment

• Incorporates a more comprehensive market
context
FAIR VALUE
ASSESSMENT
Fair PE
EPS x Fair PE Estimate • More subjective assessment
Ratio
Estimate Ratio from past
from > • Relies on 1 person’s view
• Relies on the past whose
context may not be
appropriate
Estimate
from Peers
Role Analyst Analyst
ACCOUNTING FOR EPS GROWTH
• PE Ratio is often used along side EPS Growth given that higher
2022 EPS Growth
growth justifies higher PE multiple as the number of years for 30%
earnings to accumulate and achieve stock price breakeven may Relatively Attractive
be same as a stock with lower PE multiple but slower growth. 20% J

C
• The EY approach can also include the EPS Growth dimension to G
A
improve the valuation perspective. 10% E Relatively Expensive
F
H
• To facilitate comparison, PE Ratio is often normalized by dividing
B
it by Earnings Growth. This is called the ‘PEG’ ratio. The higher 0% I
0 10 20 30 40 50
the PEG, the more expensive the stock appears to be.
2021 PE Ratio (x)
• Rather than divide PE Ratio, we multiply EY with Earnings 2022 EPS Growth
Growth and call it ‘EYG’ ratio; the higher the EYG, the more 30%
attractive it is.
20% J
Stock Price 100 C
G
EPS 4 A
EPS Growth 20% 10% E Attractive
F
PE Ratio (x) 25 H
B
PEG (PE Ratio ÷ (% EPS Growth x 100) 1.25
I
0%
EY (%) 4.0%
0.0% 5.0% 10.0% 15.0% 20.0%
EYG (EY x (% EPS Growth x 100) 0.8 2021 EY (%)
EPS Growth 10Y Gov’t Bond Yield
(reserve scale)
120% 0.0%
• THE EARNINGS YIELD APPROACH IS MORE

100% 1.0%
Stock Value based on constant EPS,
ERP and Beta but declining 10 TGB
SENSITIVE TO VALUATION CHANGES AT Yields (right scale).
80% 2.0%
LOW INTEREST RATES

60% 3.0%
• RECENTLY, SUCH BEHAVIOR HAS BEEN

40% 4.0%
Stock Value based on constant
WITNESSED MORE OFTEN FREQUENTLY, PE Ratio but rising EPS growth
(left scale).
20% 5.0%
ESPECIALLY AMONG HIGH GROWTH
0% 6.0%
STOCKS. 8 10 12 14 16 18 20 22
Stock Value
• ‘Yield’ line shows stock value based on 10Y TGB Yield and holding Equity Risk
Premium constant at 5%, Beta 1 and EPS Bt1.
• ‘PE Ratio’ line shows stock value based on changing EPS growth from EPS at Bt1
with a constant PE Ratio at 10x.
PE RATIO WORKED WELL IN THE PAST
BUT IT’S POORLY
• About two thirds of the increase in the SET PE Ratio in the last 20 years can be
explained by the fall in the 10Y TGB Yield.
• This was largely led by globalization, outsourcing (China) and major central
EQUIPPED TO HANDLE
banks’ accommodating policies.
• With rising PE ratio, most ‘Buy’ recommendations over time would work.
THE FUTURE
5.0%
10Y TGB Yield (%) 10Y UST Yield (%)
Scenario 1: China-USA
4.0% strategic conflict, Climate
change, Demographics &
3.0% Lifestyle
2.0% Scenario 2: Muddling along
1.0%
Scenario 3: Continuing trend

0.0%
25.0
23.0 SET Index PE Ratio (x)
Scenario 3
21.0
19.0
17.0 Scenario 2
15.0
13.0
11.0 Scenario 1: De-globalization,
9.0 massive capital spending and
7.0 less savings may make
5.0 inflationary pressures become
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 more lasting.
CORRELATIONS S&P500 SET
(Daily from 2006 to 2021) Index Index
THE EARNINGS YIELD
YoY Index Change vs
65% 61%
EPS Growth
APPROACH IS EVEN MORE

PE Ratio vs
10Y Government Bond -48% -78%
Yield
RELEVANT TO THAILAND
• The Earnings Yield approach is not novel. It is widely used by strategists in framing market views.
• Its theoretical framework is based on a well-established Capital Asset Pricing Model (CAPM).
• Given the high (negative) correlation between changes in 10Y TGB Yield with PE Ratio for the SET Index at -78%
compared to that of S&P500 Index at -48%, the importance of interest rate levels are more important for investors on
the SET.
• Such a strong link is also expected to prevail for smaller developing markets elsewhere.
PE Ratio Earnings Yield
Relative.
It has meaning only
Approach Absolute
when compared to
EARNINGS Judgement
something
More subjective More objective
YIELD IS Assumes same market

Can incorporate expected
market conditions in the
future including macro
Context conditions when used to
economic environment,
compare with the past
risk appetite and company
MORE risks
VERSATILE Flexibility in introducing new

factors including,
Possible with peer
comparison but not with
Risk Premium associated
with different factors can
be inferred from the bond
- ESG Risk Premium (Discount) historical comparison market, credit market or
developed equity markets.
- SME Risk Premium
The EY approach integrates market environment into the
valuation process thus, improving its quality and
predictability.
It leads investors to have a fairer expectation of future

events. This improves the decision-making process and
makes monitoring more enjoyable.
Investors new to equity markets will probably

understand EY faster than PE Ratio. EY or Yield, is already
the default description of returns for most financial
assets.
Minimal additional effort is needed by the sell-side

analysts to change from the PE Ratio method as most
information is already available.
EY approach adoption creates more accountability within

the research (between analysts, strategists and
economists), leading to more consistency in formulating
views.
SUSHEEL NARULA
สุชลี นารู ลา
Experience: 30 years of experience in equity analysis
Advisor / consultant:
• KTZMICO Securities Public Company Limited (since 2020)
• SME Board project to the STOCK EXCHANGE OF THAILAND (SET) (since 2021)
• Investment Advisor HUNTERS INVESTMENT (2017-2019)
Teaching instructor:
• CHULALONGKORN UNIVERSITY – MSF, Equity Analysis, English Program (Since 2018)
• MAHIDOL UNIVERSITY (CMMU) – Corporate Finance, Valuation Methods, English Program (Since 2020)
• ABAC – MSc IAM Program, Equity Analysis, English Program (2016-2019). Also, advisor to the program.
KASIKORNBANK GROUP (2008-2015):
• Investment Consultant to KASIKORNBANK Private Banking (2013-2015)
• Managing Director (Head of Equity Research), Kasikorn Securities (2008-2013)
SIAM COMMERCIAL BANK GROUP (2002-2007)
• Senior Vice President, Head of Strategy - Corporate Banking Group (2007)
• Managing Director (Head of Equity Research), SCB Securities (2002-2005)
Foreign brokers (1990-2002)
• Equity investment analysis with brokers including Smith New Court (Bank of America Merrill Lynch) and JF Thanakom (JP Morgan)
Academic
• MBA: Sasin Business School of Management, Bangkok. Graduated 1990
• Bachelor of Engineering (Electronics): Punjab Engineering College, Chandigarh, India. Graduated 1987
Professional interests
• Developed algorithm-based investment strategies using fundamental factors. Presently available in the market.
• Designed and copyrighted SME Competitive Intelligence (SME CI) tool set.
• Designed and copyrighted Business Scoring that provides a strategic framework for targeted development.

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WHY

WE SHOULD STOP USING

(OR MULTIPLE) HAS

BEEN THE MAIN

MAJOR EXPANSION OF 10%

IN THE LAST CYCLE 4%

Event SUB-PRIME COVID

Average PE Ratio 10 14 -10%

Source: SET, NESDB and GDP forecasts from BOT

Years to Breakeven =10

PE Ratio Stock A = 10, More Attractive

Current PE Ratio at 10 makes the stock

PE Ratio is often designated with ‘x’ as its unit. PE Ratio = 10x

Asset value at different Interest Rates and their implied PE Ratio

10% 1 Baht/10% = 10 Baht 10 Baht / 1 Baht = 10x

5% 1 Baht/5% = 20 Baht 20 / 1 = 20x

1% 1 Baht/1% = 100 Baht 100 / 1 =100x

• 10Y TGB Yield fell from an average of 3.51% in 2010 bottoming at

• This inverse relationship underlines human psychology. Lower

S&P500 SET INDEX

2010 13.0 3.19% 11.3 3.51%

2020 20.4 0.89% 16.9 1.27%

THIS RELATIONSHIP IS NOT EPS

ASSUMES THAT PEERS

- A relative multiple used to

Risks & Returns 2. Equity Asset Class

Government Bond Yield

Equity Risk Premium (ERP)

• Nature of business Beta

ECONOMY EQUITY ASSET CLASS STOCK EQUIVALENT

EQUITY INDEX 2.0% 5.0%

STOCK A (Beta =1) 2.0% 5.0% 7.0% 1/7.0% = 14.3x

STOCK B (Beta = 1.25) 2.0% 5.0% 1.25%

STOCK C (Beta = 0.8) 2.0% 4.0% 6.0% 1/6% = 16.7X

Returns to compensate for inflation risks

Equity Risk Premium Credit Risk Premium Risk-Free Rate

CONCEPT OF EQUITY RISK 5.0%

PREMIUM (ERP) IS 4.0%

CREDIT RISK PREMIUM

FOR CORPORATE BONDS

band suggests that investors adopt it as a foundation to 0%

price equity. 10%

EQUITY RISK PREMIUM (ERP) 6%

• A stock with a beta of;

= 1, stock performance expected to be similar to that of SET Index

• The information is widely available among brokers and financial platforms.

÷ Fair Risk Free Equity Risk

• More objective assessment

Role Analyst Analyst

be same as a stock with lower PE multiple but slower growth. 20% J

• THE EARNINGS YIELD APPROACH IS MORE

LOW INTEREST RATES

• RECENTLY, SUCH BEHAVIOR HAS BEEN

2.0% Scenario 2: Muddling along

Scenario 3: Continuing trend

APPROACH IS EVEN MORE

More subjective More objective

YIELD IS Assumes same market

VERSATILE Flexibility in introducing new