When you're investing, you'll want to know what sort of money you can expect and will earn on your assets, over a specified period of time.
What Is Yield?
Yield is the term for earnings generated and realized on an investment over a specific period of time, expressed in a percentage. The percentage is based on the amount invested, the current market value, or the face value of the investment security.
Yield includes interest earned, or dividends received from holding a particular security over the specific period. But it ignores capital gains. The nature and valuation - whether the valuation is fixed or fluctuates - results in yields being classified as known, or anticipated.
Thus, yield is a major decision-making tool used both by companies and investors. It is a ratio that defines how much a company pays in dividends or interest to investors each year, relative to the purchase price of the security. In other words, it is a measure of the cash flow an investor is getting on the money invested.
Gains on stock prices, accruing profits to the business, also accrue profits to shareholders. This is also why stocks with less growth potential often offer higher dividend yields to investors than stocks with high growth potential.
A high yield may have resulted from a falling market value of the security, which decreases the denominator value used in the formula and increases the calculated yield value even when the security's valuations are on a decline.
A rising stock price and rising dividend should result in a consistent or marginal rise in yield.
If a yield appears extremely high, it could be an indication that either the stock price is going down or the company is paying a high dividend, or both. A significant rise in yield without a higher stock price could indicate a company is paying a dividend without a commensurate rise in earnings, which could also suggest problems in the near future for the business.
How Is Yield Calculated?
Yield measures the cash flow an investor receives on the amount invested. It is usually computed on an annualized basis, though quarterly and monthly yields can be reported as well.
Generally, yield is calculated by dividing the dividends or interest received on a set period of time by either the amount originally invested or by its current price:
For a bond investor, the calculation is similar. As an example, if you invest $900 in a $1,000 bond that pays a 5% coupon rate, your interest income would be ($1,000 x 5%), or $50. The current yield would be ($50)/($900), or 5.56%.
If, however, you buy the same $1,000 bond at a premium of $1,100, the current yield will be ($50)/($1,100), or 4.54%. Because you paid a premium for a bond with the same fixed dollar amount of interest, the current yield is lower.
However, a high yield in either stocks or bonds can be the result of a falling market value of the security, decreasing the denominator value, even when the security's valuations are declining.
Yields vary with different types of investments in securities, the duration of the investment, and the return on it. For stock investments, two kinds of yields are generally watched - yield on cost, and current yield.
Yield on cost can be calculated by dividing the annual dividend paid and dividing it by the purchase price. The difference between yield on cost and current yield is that, rather than dividing the dividend by the purchase price, the dividend is divided by the stock's current price.
Yield on Cost = Div/Purchase Price or Current Yield = Div/Current Price
As an example, say an investor has put $100 into a stock that paid $1 as an annual dividend. The yield on cost calculation would look like this:
$1/$100 = 0.01 = 1%
If the investment made $10 during the year, and its current yield were calculated, it would look like this:
$1/$110 = 0.009 = 0.91%
As you can see, if a stock price increases and the dividend remains the same, the current yield will be lower than when the stock was originally purchased. This is because yields react inversely to stock prices.
What Is the Difference Between Yield and Return?
Yield is not, however, total return. Total return is a more comprehensive measure of return on investment, which factors in interest, dividends and capital gains. Yield is only a part of total return.
Return is the gain or loss an investment makes over a certain period of time. Like yield, as it is a ratio, return is usually quoted as a percentage.
To calculate Total Return, the purchase price is subtracted from the current price and added to the dividend, then is divided by the original purchase price:
(CP-PP)+Div/PP = TR
So, at is most basic, if an investor purchases a stock for $100, which pays an annual dividend of $3, and sells it for $153, the capital gain plus dividend of the stock would be $56.
Therefore, the total return would be: [($153-$100)+3]/$100 = 0.56 = 56% on the initial investment.
As another example, stock investment gains can come in two forms: in terms of price rise, and in terms of a dividend.
If an investor buys a stock at $100 per share, and the stock price rises to $120 in a year, the stock investment gain is $20. The stock may also pay a dividend of $2 per share, during the year.
The appreciation of the share price plus any dividends paid in a year, divided by the original price of the stock, is the total return.
The yield won't include variations observed in the price of the security, like changes in the share price on its way to $120. That's where yield differs from total return. Yield is a part of the total return generated from holding an invested in financial security over a year.
What Is the Highest Yield Investment?
Because higher yields are often an indicator of higher risk, a number of high yield investments attract those with more risk appetite than aversion.
Among the potential higher-yielding investments are high yield bonds, Canadian Income Trusts, Master Limited Partnerships, Dividend Paying Stocks, Preferred Stocks, Real Estate Investment Trusts, and High Yield Bonds.
The dividends on preferred stocks are paid at a fixed rate, and companies are required to pay preferred stockholders dividends before common stockholders, which can make them attractive for high-yield investors.
Meanwhile, high-yield bonds tend to be offered by companies that present more risk than others. High-yield bonds have been referred to as "junk" because the companies have to pay a higher yield to attract investors. While individual high-yield bonds can be purchased, high-yield bond mutual funds offer more investment diversity.
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