Why deal with the S&P 500 when savings accounts pay 5%? That's exactly why many rich people are dumping stocks for cash. But the so-called Fed Model points to stocks that might still be worth your while.
Nine stocks in the S&P 500 — including health care plays Viatris and Organon and financial name Lincoln National — sport forward earnings yields of 18% or higher, says an Investor's Business Daily analysis of data from S&P Global Market Intelligence and MarketSmith. In other words, these companies are seen generating profit this year that translate into 19% potential returns (not including dividends).
And that's a solid return in a world in which three-month Treasuries yield 5.3% and 10-years yield 3.7%. This analysis gauges how expensive stocks are compared with long-term Treasuries using the reciprocal of the forward P-E ratio. The earnings yield "offers a quick-and-dirty guide to potential returns," says The Economist.
Paying Too Much For S&P 500 Stocks
If cash is looking more alluring, it's not just you. It's a mathematical fact.
The average forward earnings yield of S&P 500 stocks with valid 2023 estimates is just 6.5%, based on S&P Global Market Intelligence data. And it's only 5.3% for the S&P 500 adjusted for market value, says The Economist.
Too low? Why bother with the stress of earnings reports and crashes when you can get the exact same return from three-month Treasuries?
"This means stockholders are taking the risk of owning equities for an expected return that the Fed may shortly be offering risk free," The Economist said. "Stay tuned for more drama."
Take Nvidia, for instance. Thanks to the AI champion's heroic 165% stock rally this year, its earnings yield is just 2%. And it doesn't pay a dividend either. The company's future profit estimates will need to rise quite a bit before it's competitive with lower-risk options. But analysts already think the company's profit will jump 132% this fiscal year. How much more can it go up?
Finding Fed Values In The S&P 500
If Nvidia's future returns are too low, says the Fed Model, where can you get better ones?
Take a look at Viatris, a generic-drug developer. The S&P 500 stock, down 14% this year, touts a forward P-E yield of 31.7%. That's higher than any earnings yield in the S&P 500.
Yes, you'll need to deal with disappointment. Shares are down 14.4% this year. But you're at least getting a shot at solid long-term returns. Analysts see the company returning to profit growth in 2025. And they seem to agree with the Fed Model. Analysts rate the stock outperform with a 12-month price target of 12.66 a share. If they're right, that's more than 30% in potential upside.
Analysts aren't so sure on the other S&P 500 stocks with the highest earnings yields. Lincoln National sports a lofty forward earnings yield of 31.3%. It pays an 8% dividend yield on top of that. Not bad. And yet, analysts rate it just a hold amid the financial crisis. Shares are down 24% this year.
Similarly, women's health company Organon has seen shares drop 28% this year. And yet its earnings yield is a tempting 21.1%.
Is the Fed Model a fail-safe stock-picking tool? Absolutely not. You should consult with time-tested growth stock measures instead. But the Fed Model still explains why so many people are sticking to cash, and why they might possibly regret it later.
Fed Model Favorites
Highest forward earnings yields among S&P 500 companies
| Company | Ticker | Forward earnings yield | Sector | Analysts' avg. rating |
|---|---|---|---|---|
| Viatris | 31.1% | Health Care | Outperform | |
| Lincoln National | 30.3 | Financials | Hold | |
| Organon | 21.2 | Health Care | Hold | |
| Valero Energy | 20.3 | Energy | Outperform | |
| NRG Energy | 19.1 | Utilities | Hold | |
| General Motors | 19.1 | Consumer Discretionary | Outperform | |
| United Airlines Holdings | 18.9 | Industrials | Outperform | |
| Comerica | 18.8 | Financials | Outperform | |
| American Airlines | 18.8 | Industrials | Hold |
Sources: S&P Global Market Intelligence, IBD
Follow Matt Krantz on Twitter @mattkrantz
