When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.
How to earn a yield in stocks?
Yield in stocks, via dividends, is a great way to diversify your source of potential earnings away from just capital gains when stock prices rise.
QUOTE
"I do not own a single security anywhere that doesn't pay a dividend, and I formed a mutual-fund company with that very simple philosophy."
To make the most out of your investment, you need to comprehend the yield meaning in finance. The concept of yield can have different meanings depending on the financial product in question. It is especially relevant to the fixed income market. However, this article is going to focus primarily on yield in stocks as opposed to bonds, real estate, and other investment vehicles.
Yield meaning (in Finance, it’s all about returns)
DEFINITION
Yield is the realised earnings on an investment over a specific time period. It differs from the interest rate, though the interest rate is the main determinant of the yield.
Yield is always expressed as a percentage of the invested amount. Changes in the price of the asset can also increase or decrease the yield. Yields are usually calculated annually, though they can also be expressed monthly or quarterly.
EXAMPLE
If you invested $10,000 in a security and earned $500, the yield is 5%.
The interest rate might only have been 3.5%, but other criteria, such as changes in price, could have increased the yield.
If the price of the security fell to $5,000, your yield has improved to 10%, though you lost an additional $5,000.
The interest rate might only have been 3.5%, but other criteria, such as changes in price, could have increased the yield.
If the price of the security fell to $5,000, your yield has improved to 10%, though you lost an additional $5,000.
A high yield is a good indicator of a potentially high reward, but other factors have to be looked at - specifically, factors that impact risk. A high yield can be the result of a falling market value.
How to calculate yield in stocks?
Calculating stock yields is relatively straightforward. There are two primary formulas to measure yield in stocks - cost yield and current yield.
For the cost yield, you simply add the price increase and the dividends divided by the initial investment price.
For the cost yield, you simply add the price increase and the dividends divided by the initial investment price.
FORMULA & EXAMPLE
Cost Yield = (Price Increase + Dividends)/Initial Price
You purchased a stock for $100, and it increased in value by $20 and paid out a $10 annual dividend.
You would have a cost yield of 30% = (20 +10)/100.
The cost yield is 0.3 (expressed as 30% as a percentage).
You purchased a stock for $100, and it increased in value by $20 and paid out a $10 annual dividend.
You would have a cost yield of 30% = (20 +10)/100.
The cost yield is 0.3 (expressed as 30% as a percentage).
The current yield is lower than the cost yield. The only difference is that the current yield takes the current price into account instead of the initial price.
FORMULA & EXAMPLE
Current Yield = (Price Increase + Dividends)/Current Price
Using the same example as above, this would be (20 + 10)/120. This generates a 25% yield.
Using the same example as above, this would be (20 + 10)/120. This generates a 25% yield.
Of course, the value of the underlying stock could easily decrease instead of increase. Current yields and cost yields are both types of dividend yields in stocks. This is because both of these yields take dividends into account for their equations.
Dividend yield in stocks - things to consider
Investors tend to think more about dividend stocks when growth stocks start to underperform. But there are factors to consider, such as:
- The best yields can be tied to investments with little or no growth potential. There is little point in searching for the best yield if the share price is going down.
- Consistency of dividends. You want to find a company with a track record of paying dividends and that has the strength to last through thick and thin. Ideally, you would look for a company with a dividend of 2% - 4%, a 5-year annualised dividend growth of 5% - 15%, and a 5-year annualised earnings per share of 10% - 30%. However, these figures should vary with the type of business you invest in.
For investors looking to take advantage of dividend reinvestment and to stay secure against inflation, dividend-paying companies are ideal.
Source: Mint.intuitA list of criteria when selecting companies might include:
- Dividend increases - Increase dividends for most (ideally all) of the years in the past decade.
- Consistent profits - Very few or no unprofitable years in the past 10 years.
- Earnings per share - EPS should have increased each year on average.
- Yields - should ideally be over 1%.
It’s also helpful if the stock outperformed the market and has a low volatility profile. Drawdowns above 50% in a given year are a worrisome indicator for investors interested in stable dividend yield in stocks.
What about yields in bonds?
A bond is a loan in return for interest payments. Every bond has a maturity date in which the principal is paid back alongside all the interest payments.
Just like the stock price, however, the bond may go up or down in value, reducing or increasing the total yield. This affects the actual yield of the bond. The calculation of bond yields is different and has different terminology. All bonds have a maturity date and a “coupon”, or a periodic interest payment.
Just like the stock price, however, the bond may go up or down in value, reducing or increasing the total yield. This affects the actual yield of the bond. The calculation of bond yields is different and has different terminology. All bonds have a maturity date and a “coupon”, or a periodic interest payment.
EXAMPLE
A $10,000 bond might have a coupon of 8% and a maturity date of 8 years. It generates $800 for the investor each year for 8 years when the principal is returned. It has a current yield of 8%.
Most investors will look at the yield to maturity (YTM), which is a more complex calculation and takes compound interest and reinvestment risk into account. When comparing bonds, the yield to maturity is often used instead of the current yield.
Of course, you needn’t do this calculation yourself! Online bond calculators are available that will help you to arrive at a correct value quickly.
The thing to keep in mind about bond prices is that a decrease in price increases the current yield. This means that while you earn more in interest payments, the amount you receive if you sell immediately will be less. As bond prices increase, yields decrease.
The thing to keep in mind about bond prices is that a decrease in price increases the current yield. This means that while you earn more in interest payments, the amount you receive if you sell immediately will be less. As bond prices increase, yields decrease.
What’s the difference between current yield and yield to maturity?
The current yield is concerned with how much a bond generates in a given year or time period.
The yield to maturity (YTM) is concerned with the entire bond cash flow to show you what you can earn when all factors are taken into consideration.
In other words, the YTM takes everything into account and gives you the most accurate figure. The current yield is not as broad in comparison and is only useful to investors who expect to hold the bond to maturity no matter what.
The yield to maturity (YTM) is concerned with the entire bond cash flow to show you what you can earn when all factors are taken into consideration.
In other words, the YTM takes everything into account and gives you the most accurate figure. The current yield is not as broad in comparison and is only useful to investors who expect to hold the bond to maturity no matter what.
CURRENT YIELD | YIELD TO MATURITY | |
Time horizon | 1 year | Purchase to maturity |
Measures | Income | Total return |
Formula | Coupon or Price | Quote tables/Excel |
Investor focus | Income | Overall performance |
Other types of yields for bonds
The yield to maturity is the most common and comprehensive formula when calculating bond performance. But there are two other types of yield calculations for bonds that can also be very informative. These are the yield to worst, which is very similar to the yield to call. These are often treated the same in bond yield formulas.
The yield to worst (YTW) is the worst yield that a bond can generate without defaulting.
This kind of yield only applies to bonds that have specific provisions so they can be called before full maturity. These bonds are known as callable bonds. This helps investors to mitigate risks in a worst-case scenario. A bond might be called early if the yields are low and a better bond is available elsewhere. In the case of a non-callable bond, the yield to call and the yield to maturity are one and the same.
The yield to worst (YTW) is the worst yield that a bond can generate without defaulting.
This kind of yield only applies to bonds that have specific provisions so they can be called before full maturity. These bonds are known as callable bonds. This helps investors to mitigate risks in a worst-case scenario. A bond might be called early if the yields are low and a better bond is available elsewhere. In the case of a non-callable bond, the yield to call and the yield to maturity are one and the same.
FORMULA
YTC = (Coupon Interest Payment + (Call Price - Market Value) ÷ Number Of Years Until Call) ÷ (( Call Price + Market Value ) ÷ 2 )
Bond investors might also want to look into the nominal yield and running yield, which are quite similar. The nominal yield is a percentage expressed over the face value of the bond, while the running yield is a percentage expressed over the current market price.
So a bond might have a face value of $1,000 and a coupon of 4%, with a nominal yield of $40. However, if the current market value of the bond is $900, the running yield is $44. If the face and market value are both the same, then the nominal and running yield will be the same.
So a bond might have a face value of $1,000 and a coupon of 4%, with a nominal yield of $40. However, if the current market value of the bond is $900, the running yield is $44. If the face and market value are both the same, then the nominal and running yield will be the same.
Current yield vs yield to maturity example
The table below should give an indication of the differences between the current yield and the yield to maturity. This is useful because it can certainly take some time to wrap your head around bond yields, which can be much more complex than dividend yield in stocks.
COUPON | MATURITY | CURRENT PRICE | CURRENT YIELD | YTM | |
Bond A | 6% | 7 years | $1,300 | 5.5% | 3.1% |
Bond B | 4% | 7 years | $950 | 3.2% | 3.7% |
Notice how even though Bond B has a lower coupon and current yield than Bond A, it is still a better investment based on the Yield to Maturity, at 3.7% as opposed to 3.1%. The difference is due to the current market price for each bond.
When the bond matures, the investor of Bond A will receive significantly less than the current market price. This difference is factored into the YTM, and not the coupon or current yield, which is why the YTM is more accurate.
Bonds are typically priced at a par value of $1,000. Bonds that trade for less than par trade are said to trade at a discount, while bonds that trade for more than par value trade at a premium. Below, Bond B trades at a discount, while Bond A trades at a premium.
When the bond matures, the investor of Bond A will receive significantly less than the current market price. This difference is factored into the YTM, and not the coupon or current yield, which is why the YTM is more accurate.
Bonds are typically priced at a par value of $1,000. Bonds that trade for less than par trade are said to trade at a discount, while bonds that trade for more than par value trade at a premium. Below, Bond B trades at a discount, while Bond A trades at a premium.
Understanding real estate yields
Real estate also generates yields, though rental income does not equate to true yield (just ask a landlord). There are a lot of costs to consider to arrive at the true yield from renting a property.
You can measure real estate yield when considering a rental property purchase, provided you can reliably estimate the monthly rental and the cost of upkeep. A $500,000 apartment that rents at $2,500 per month with an upkeep of $500 will have an annual yield of 4.8%.
This is quite impressive if you can rent for this amount and have such a minimum upkeep. More realistically, the costs and upkeep will be more, there will be other associated costs, and you may not get the apartment rented year-round.
However, you can also invest in Real Estate Investment Trusts (REITs). REITs pay out in dividends, and you can gain the benefit of real estate rental without actually owning property yourself. While enticing, you’ll need to crunch the figures to see the real yield before you invest your hard-earned money.
You can measure real estate yield when considering a rental property purchase, provided you can reliably estimate the monthly rental and the cost of upkeep. A $500,000 apartment that rents at $2,500 per month with an upkeep of $500 will have an annual yield of 4.8%.
This is quite impressive if you can rent for this amount and have such a minimum upkeep. More realistically, the costs and upkeep will be more, there will be other associated costs, and you may not get the apartment rented year-round.
However, you can also invest in Real Estate Investment Trusts (REITs). REITs pay out in dividends, and you can gain the benefit of real estate rental without actually owning property yourself. While enticing, you’ll need to crunch the figures to see the real yield before you invest your hard-earned money.
The importance of dividend yield in stocks
Dividend reinvestment and dollar cost averaging are very popular for long-term investments. Many of the world’s greatest investors have pointed out the strengths of choosing companies with strong reputations for dividend payouts.
The power of compound interest and continual investment at set intervals is a great way to minimise volatility and limit the time needed to continually choose “winning” stocks, which is practically impossible for people to do on a regular basis. With a dividend reinvestment program, a winning stock is one that pays decent dividends to shareholders and grows slowly but steadily, year on year.
The power of compound interest and continual investment at set intervals is a great way to minimise volatility and limit the time needed to continually choose “winning” stocks, which is practically impossible for people to do on a regular basis. With a dividend reinvestment program, a winning stock is one that pays decent dividends to shareholders and grows slowly but steadily, year on year.
QUOTE
“The true investor ... will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.”
It’s easy to find companies to select based on dividends and also far easier to calculate dividend yield in stocks than the YTM for bonds. But there is nothing stopping you from doing both. You could have a portfolio that is mainly equities (stocks) that pay dividends, combined with a fixed bond that generates a certain YTM over a set period of time.
Trading 212’s AutoInvest and Pies makes it very easy to design a yield-bearing stock portfolio. You can also invest in bond funds and access major equities, and choose the ones that pay a generous dividend yield in stocks.
Trading 212’s AutoInvest and Pies makes it very easy to design a yield-bearing stock portfolio. You can also invest in bond funds and access major equities, and choose the ones that pay a generous dividend yield in stocks.
Yield on stocks pros
✔️ Can be used as part of a dividend reinvestment plan
✔️ Can be higher than bonds
✔️ Can also benefit from stock appreciation
✔️ Can be higher than bonds
✔️ Can also benefit from stock appreciation
Yield on stocks cons
❌ Not all companies offer dividend yields on stocks.
❌ Stock prices can fluctuate or crash.
❌ Stock prices can fluctuate or crash.
Yield on bonds pros
✔️ Steady and predictable rate of return
✔️ Good hedge against inflation
✔️ Lump sum return at the end provides a consistent income
✔️ Good hedge against inflation
✔️ Lump sum return at the end provides a consistent income
Yield on bond cons
❌ Low rate of return
❌ Money on bonds could have been invested in a more attractive security
❌ Money on bonds could have been invested in a more attractive security
Recap
Understanding yield in stocks is one of the most powerful and effective ways to try to grow your wealth over time. Why disregard a dividend yield that could compound annually, especially if you are a younger investor?
It’s also important to understand yield in fixed-income instruments such as bonds. The yield to maturity is essential to gauging the true yield of a stock considering its current price. Calculating the YTM is easy with the help of an online calculator.
It’s also important to understand yield in fixed-income instruments such as bonds. The yield to maturity is essential to gauging the true yield of a stock considering its current price. Calculating the YTM is easy with the help of an online calculator.
FAQ
Q: What is yield in investment?
The yield refers to the total amount that would be earned when all factors are included for a given security. This is different from the interest rate because the interest rate only relates to the return on a given security. There are other factors which could increase or decrease yield, most commonly the rise or fall in the price of the underlying security. There are many formulas to calculate the yield that take different criteria into account, especially in the bond market.
Q: What is a good yield for a stock?
A good dividend yield for a stock is generally considered between 2% - 4%, but this varies based on the level of inflation.
If the yield is above 4%, it could be a great buy, but it could also be quite risky. There is a reason the yield is so high, so make sure you do your research before investing in high-yield stocks. Remember that dividend is expressed as a percentage of the stock price, so a lower stock price would result in a higher yield.
Also, remember that a lower dividend, or no dividend, means that the company is likely reinvesting its earnings. This could ultimately mean no yield but a much higher stock price.
If the yield is above 4%, it could be a great buy, but it could also be quite risky. There is a reason the yield is so high, so make sure you do your research before investing in high-yield stocks. Remember that dividend is expressed as a percentage of the stock price, so a lower stock price would result in a higher yield.
Also, remember that a lower dividend, or no dividend, means that the company is likely reinvesting its earnings. This could ultimately mean no yield but a much higher stock price.
Q: Is yield the same as dividend?
The yield is technically called dividend yield in stocks. But the term dividend is usually expressed as a total dollar amount in terms of stock. Yields in stocks and stock dividends are not the same in terms of how they are expressed (a percentage vs a dollar amount).
The dividend yield is the most commonly used because it gives a more accurate picture in terms of the dividend as a percentage of the share price. The dividend rate is commonly referred to as the dividend per share (DPS). Note that dividend yield can vary by company, sector, and location.
The dividend yield is the most commonly used because it gives a more accurate picture in terms of the dividend as a percentage of the share price. The dividend rate is commonly referred to as the dividend per share (DPS). Note that dividend yield can vary by company, sector, and location.
Q: Is increasing yield a good thing?
If everything else remains equal, increasing yield is good. But in investing, things rarely remain equal. An increase in yield means you make more profits. But if the increase in yield occurred because the share price went down, then you have actually lost money.
The same applies to bond yields. You might have a better current yield, but the yield to maturity will display a more accurate picture that accounts for the bond price and other variables. When you see a high yield, be sure to understand why the yield is high and how it could affect your investment.
The same applies to bond yields. You might have a better current yield, but the yield to maturity will display a more accurate picture that accounts for the bond price and other variables. When you see a high yield, be sure to understand why the yield is high and how it could affect your investment.
Q: Which stock has the highest dividend?
There are plenty of stocks that pay monthly dividends of 4% - 8%. But many of these are not safe or secure, so it’s better to look for high dividend payments from established companies and to look at their track records of paying dividends.
Lockheed Martin Corporation pays 3% in dividends, and it has an excellent track record (18 years) of paying dividends. Cisco, Procter & Gamble, Johnson & Johnson, and Walmart are stable companies that pay out high dividends but not suspiciously high dividends that are unsustainable. Just remember that even companies with a good track record of stable payouts can change the dividend at any time.
Lockheed Martin Corporation pays 3% in dividends, and it has an excellent track record (18 years) of paying dividends. Cisco, Procter & Gamble, Johnson & Johnson, and Walmart are stable companies that pay out high dividends but not suspiciously high dividends that are unsustainable. Just remember that even companies with a good track record of stable payouts can change the dividend at any time.
Q: What is the yield to worst?
The yield to worst (YTW) is the lowest possible return a lender could earn if the bond matured or was called early. However, this only applies to callable bonds. For a non-callable bond, the YTW is basically the same as the maturity date.
Brokerages should provide both the yield to maturity and the YTW when offering callable bonds. If the bond has many call dates, the YTW is the earliest possible rate at each call date. The yield to worst is often the same as the yield to call.
Brokerages should provide both the yield to maturity and the YTW when offering callable bonds. If the bond has many call dates, the YTW is the earliest possible rate at each call date. The yield to worst is often the same as the yield to call.
Q: What is a dividend trap?
This is when a dividend is high but for suspicious reasons. It most commonly refers to when the yield on an instrument has risen because the price of the underlying security has fallen. Thankfully, it is easy to identify dividend traps in many instances by checking the price of the underlying security. When an annual dividend goes from 2% each year to 5%, it definitely bears investigation.
