Beyond headline indices and P/E multiples, one under-the-radar tool can help investors assess when equities offer more bang for the buck than bonds—and vice versa. It’s called the earnings yield to bond yield ratio, and it might just give you a smarter lens into market valuation.
What is earnings yield—and how is it calculated?
Think of earnings yield as the return you’d get for every rupee you invest in equities. It’s simply the inverse of the price-to-earnings (P/E) ratio. For example, say the Nifty50 index is at 25,000 and the combined earnings per share (EPS) of its constituent companies is ₹1,120. Dividing 25,000 by 1,120 gives a P/E ratio of 22.32. Inverting this gives an earnings yield of 4.48%. That means, based on trailing twelve-month (TTM) earnings, you’re earning ₹1,120 on a ₹25,000 investment.
Note that this is based on TTM EPS. If you use projected earnings, the P/E would be lower and the earnings yield correspondingly higher, which can alter the attractiveness of equities.
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Now, compare it with bond yields
The benchmark for bond yields is the 10-year Indian government bond (G-Sec). This yield is considered risk-free if held to maturity. As of now, the 10-year G-Sec yield is around 6.23%, which is significantly higher than the 4.48% earnings yield of the Nifty.
G-Secs are considered risk-free because they carry no credit risk, and if held to maturity, they also eliminate market risk—even if bond prices fluctuate in the interim.
So, why would anyone invest in equities then?
The catch here is that bond yields are fixed—6.23% today means 6.23% for the next 10 years. But equity earnings can grow over time with the economy. This growth potential isn’t captured by current earnings yield, which is why investors still flock to equities despite their lower starting returns.
Also read: Credit quality of debt investments: more positives, few negatives
What does history tell us?
In India, the bond yield has typically been 1.5x the earnings yield. So, if Nifty’s earnings yield is 4.48%, then 6.72% (4.48% × 1.5) is the long-term ‘equilibrium’ point.
The 1.5x multiple reflects the historical relationship in India, where bond yields have typically exceeded earnings yield. It also implicitly accounts for long-term earnings growth potential in equities—something bonds lack.
When the G-Sec yield crosses this threshold, bonds become relatively more attractive. Today, with bond yield at 6.23%, equities are still in the game—especially if you expect growth.
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Conclusion
This isn’t a replacement for your financial plan. Asset allocation should still be based on your goals, investment horizon, and risk appetite. But the earnings yield to bond yield ratio can help at the margin—to tweak your mix of equity and debt if you’re actively managing a portfolio.
This yield comparison is a helpful tool—not a golden rule. Think of it as an additional filter when evaluating markets. If you’re a long-term investor betting on growth, equities may still hold the edge, even when bond yields look tempting.
Joydeep Sen is a corporate trainer (financial markets) and author