To Ridge,
Yes you are right, we should use EPS%. We should also factor in EPS growth and risk premiums, but I want to keep the example simple.
To Juz,
Sorry, I don't get it. Please help me understand.
Let's use a simple example. Assume SAFESTOCK (STK) has a dividend of $1 a share. The EPS growth rate is zero and the earnings are 100% safe, so the stock yield is perfectly correlated with interest rates. The stock trades at $10 a share giving a yield of 10%. Interest rates are also 10%.
Suddenly interest rates drop to 5%. What price would STK be?
a. $20 (= STK yield of 5%)
b. $5 (= STK yield of 20%)
The correct answer is (a). Your posting implies the answer is (b). Please clarify things. What is the correct answer in your opinion?
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