Financial Equalization 1015266 1280
25-Oct-2020 By - team

Yield refers to the earnings generated and realized on an investment over a particular period. It’s expressed as a percentage based on the invested amount, current market value, or face value of the security. It includes the interest earned or dividends received from holding a particular security. Depending on the valuation (fixed vs. fluctuating) of the deposit, yields may be classified as known or anticipated.

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Yield is defined as an income-only return on investment (it excludes capital gains) calculated by taking dividends, coupons, or net income and dividing them by the value of the investment, expressed as an annual percentage. Yield tells investors how much income they will earn each year relative to the market value or initial cost of their investment. The average product of stocks on the S&P 500, for example, typically ranges between 2.0 – 4.0%.

Not all the tools of real analysis work for every investor on every stock. If you’re looking for high-growth technology stocks, they’re not likely to turn up in any stock screens you might run looking for dividend-paying characteristics. However, if you’re a value investor or looking for dividend income, a couple of measurements are specific to you. One of the telling metrics for dividend investors is the dividend yield, which is a financial ratio that shows how much a company pays out in dividends each year relative to its share price.

Dividend yield can technically be calculated for any time period but is almost always expressed as an annualized percentage. A stock’s dividend yield is defined as the amount of money it pays its shareholders each year, as a percentage of its current stock price.

For example, if a stock’s current share price is $100, and it pays dividends at a $5 annual rate, its dividend yield is currently 5%.

It’s also worth noting that since stock prices change frequently, so does dividend yield. This is especially true with volatile stocks, where dividend yields can fluctuate considerably from one day to the next. This fact is the main reason it can be so useful to know how to calculate dividend yield. Many stock quotes only update their dividend yield calculation once per day, not continuously. By learning how to calculate dividend yield on your own, you can get an instantaneous dividend yield for any stock, which can help you make better-informed investment decisions, particularly on days where stock prices experience big moves.

Types of Yields

Yields can vary based on the invested security, the duration of investment and the return amount.

Yield on Stocks

For stock-based investments, two types of yields are popularly used. When calculated based on the purchase price, the yield is called yield on cost (YOC), or cost yield, and is calculated as:

Cost Yield = (Price Increase + Dividends Paid) / Purchase Price

 

In the above-cited example, the investor realized a profit of $20 ($120 – $100) resulting from price rise, and also gained $2 from a dividend paid by the company. Therefore, the cost yield comes to ($20 + $2) / $100 = 0.22, or 22%.

 

However, many investors may like to calculate the yield based on the current market price instead of the purchase price. This yield is referred to as the current yield and is calculated as:

Current Yield = (Price Increase + Dividend Paid) / Current Price

 

In the above example, the current yield comes to ($20 + $2) / $120 = 0.1833, or 18.33%.

When a company’s stock price increases, the current yield goes down because of the inverse relationship between product and stock price.

Yield on Bonds

The yield on bonds that pay annual interest can be calculated in a straightforward manner—called the nominal yield, which is calculated as:

Little product = (Annual Interest Earned / Face Value of Bond)

For example, if there is a Treasury bond with a face value of $1,000 that matures in one year and pays 5% annual interest, its yield is calculated as $50 / $1,000 = 0.05 or 5%

However, the creation of a floating interest rate bond, which pays a variable interest over its tenure, will change over the life of the bond depending upon the applicable interest rate at different terms.

If there is a bond that pays interest based on the 10-year Treasury yield + 2%, then its applicable interest will be 3% when the 10-year Treasury yield is 1% and will change to 4% if the 10-year Treasury yield increases to 2% after a few months.

In the simplest form, the average yield calculation equals the investment’s annual income divided by the cost of acquisition. The average yield on an investment is related to another important financial calculation, the return on investment (ROI), but involves a different calculation for a somewhat different purpose. The more widely known ROI is essentially backward-looking – what was the percentage made? The average yield expresses an investment’s present or future state.

How to Calculate the Yield of Your Income Stock Investment

The main thing to look for in choosing income stocks is yield: the percentage rate of return paid on a stock in the form of dividends. Looking at a stock’s dividend yield is the quickest way to find out how much money you’ll earn from a particular income stock versus other dividend-paying stocks (or even other investments, such as a bank account).

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, the 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, 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.

The yield on cost can be calculated by dividing the annual dividend paid and dividing it by the purchase price. The difference between the yield on cost and the current yield is that, rather than dividing the dividend by the purchase price, the dividend is divided by the stock’s current price.

The 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%

Calculating yield on cost is similar to calculating a stock’s dividend yield. The first step is to find a company’s annual dividend payout per share. A company’s annual dividend then needs to be divided by the investor’s cost basis per share. An investor’s cost basis represents the price he paid to acquire his shares.

Let’s try an example. Suppose I bought 50 shares of Colgate at $55 per share. Suppose the stock currently trades at $70 and pays annual dividends of $1.56 per share.

The company’s dividend yield would be 2.2% ($1.56 per share in dividends / $70 current stock price). However, my yield on cost would be 2.8% ($1.56 per share in dividends / $55 cost basis per share). If Colgate raised its dividend by 8% to $1.68 per share, my yield on cost would rise to 3.1% ($1.68 per share in dividends / $55 cost basis per share).

The yield on cost increases when a company raises its dividend and decreases when a company cuts its dividend. Cost basis information can become complicated as investors make additional purchases of existing holdings through direct purchases or dividend reinvestment plans.

Fortunately, brokers can supply investors with their cost basis information for each of their holdings. The yield on cost highlights the power of a dividend growth strategy and can be useful for retirement planning. For example, suppose in 2016, we invested $100,000 in Colgate and purchased shares at a price of $73 per share. The company paid dividends of $1.56 per year, resulting in an initial yield on cost of 2.14% and annual dividend income of approximately $2,137.

If Colgate grew its dividend by 8% per year from 2017 through 2025, the yield on cost of our investment would double from 2.14% to 4.27%. Instead of generating $2,137 of dividend income per year, our original investment of $100,000 would now be throwing off about $4,272 of annual dividend income. If dividends were being reinvested over this time, our future income would be even higher.

This is a key advantage that dividend growth investing has over purchasing bonds with fixed interest rates. While stocks are much more volatile investments, a bond paying 2% today will still be paying 2% in the future – regardless of inflation.

Quality dividend stocks provide an opportunity to earn a higher income on our original investment over time, but it doesn’t happen overnight.

Despite the excitement created by a rising yield on cost, investors must remain aware that yield on cost is mostly a backwards-looking measure.

The yield on cost tells us little about a company’s future growth potential and underlying business fundamentals. The yield on cost informs an investor whether a stock’s dividend has been rising or falling since the investment was purchased, and we shouldn’t necessarily extrapolate the past.

 Perhaps more importantly, we need to guard ourselves from falling in love with a holding simply because it has a high yield on cost. Investors should resist the emotional temptation to hold a stock with high yield on cost if the investment is no longer attractive.

There is always an opportunity cost to consider from holding stock, and it’s important to remember that dividend income is only part of the total return equation. Personally, the yield on cost does not play a role in my investment decisions or process to build a dividend portfolio. I instead try to focus on actionable metrics that can provide clues about a company’s future.

My goal is to own businesses that can consistently grow their earnings over the long term to provide me with rising dividend income and a more valuable portfolio over time.

By studying how an industry works, reviewing a company’s track record, and analyzing a number of financial ratios, I can make progress on my goal.

The yield on cost doesn’t really help me accomplish any of these things, but it should steadily rise over time if my efforts are successful.

In other words, I view yield on cost as an output of my investment process – not an input.

If the investment made $10 during the year, and its current yield was 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.

Yield is a measure of cash flow that an investor gets on the amount invested in a security. It is mostly computed on an annual basis, though other variations like quarterly and monthly yields are also used. Yield should not be confused with total return, which is a more comprehensive measure of return on investment. Yield is calculated as:

Yield = Net Realized Return / Principal Amount

For example, the gains and return on stock investments can come in two forms. First, it can be in terms of price rise, where an investor purchases a stock at $100 per share, and after a year, they sell it for $120. Second, the stock may pay a dividend, say of $2 per share, during the year. The yield would be the appreciation in the share price plus any dividends paid, divided by the original price of the stock. The yield for the example would be:

($20 + $2) / $100 = 0.22, or 22%

Volume 75%

The dividend yield is shown as a percentage and calculated by dividing the dollar value of dividends paid per share in a particular year by the dollar value of one share of stock.

Yields for a current year can be estimated using the previous year’s dividend or by multiplying the latest quarterly dividend by 4, then dividing by the current share price.

The dividend yield is a method used to measure the amount of cash flow you’re getting back for each dollar you invest in an equity position. In other words, it’s a measurement of how much bang for your buck you’re getting from dividends. The dividend yield is essentially the return on investment for a stock without any capital gains.

Suppose company ABC’s stock is trading at $20 and pays yearly dividends of $1 per share to its shareholders. Also, suppose that company XYZ’s stock is trading at $40 and also pays annual dividends of $1 per share. Company ABC’s dividend yield is 5% (1 ÷ 20), while XYZ’s dividend yield is only 2.5% (1 ÷ 40). Assuming all other factors are equivalent, an investor looking to use their portfolio to supplement their income would likely prefer ABC’s stock over that of XYZ, as it has double the dividend yield.

Financial Charts And Graphs

Investors who need minimum cash flow from their investments can secure it by investing in stocks paying high, stable dividend yields. Older, well-established companies usually pay out a higher percentage in dividends than younger companies, and older companies’ dividend history is also generally more consistent.

What Yield Can Tell You

Since a higher yield value indicates that an investor is able to recover higher amounts of cash flows in his investments, a higher value is often perceived as an indicator of lower risk and higher income. However, care should be taken to understand the calculations involved. 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.

While many investors prefer dividend payments from stocks, it is also important to keep an eye on yields. If yields become too high, it may indicate that either the stock price is going down or the company is paying high dividends. Since dividends are paid from the company’s earnings, higher dividend payouts could mean the company’s revenues are on the rise, which could lead to higher stock prices. Higher dividends with higher stock prices should lead to a consistent or marginal rise in yield. However, a significant increase in yield without a rise in the stock price may mean that the company is paying dividends without increasing earnings, and that may indicate near-term cash flow problems.

 

 

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