TL;DR
Yield refers to the earnings generated and realized on an investment over a specific period, expressed as a percentage of the investment’s cost, market price, or face value.
Yield is most commonly used to describe the return on bonds (interest or coupon payments) or stocks (dividends), but it can also apply to other types of investments, such as real estate or commodities.
In simple terms, yield measures how much cash flow you get from an investment relative to what you initially invested or what the investment is currently worth.
Investors use yield to gauge how profitable an investment is, particularly for income-generating assets.
How is Yield Calculated?
Yield is calculated by dividing the income generated from an investment by its price or cost. The formula for calculating yield depends on the type of investment and the context in which yield is being measured.
However, the general formula is:
Types of Yield
There are several types of yield, each providing different insights into an investment’s performance. The most common types of yield include:
1. Dividend Yield
Dividend Yield refers to the annual dividend income generated by a stock, expressed as a percentage of the stock’s current price. It helps investors evaluate the income they can expect to earn from dividends relative to the stock’s price.
- Formula:
2. Bond Yield
Bond Yield measures the return an investor earns on a bond based on the bond’s coupon payments (interest payments). There are two main types of bond yield:
- Current Yield: This measures the annual interest payments as a percentage of the bond’s current market price.
- Yield to Maturity (YTM): This is a more comprehensive measure that accounts for the bond’s current price, coupon payments, and the time remaining until maturity. YTM estimates the total return an investor will receive if the bond is held until it matures.
3. Yield on Cost (YOC)
Yield on Cost is the dividend yield based on the original cost of the investment rather than its current market value.
This metric is useful for long-term investors who want to track how much income they’re earning relative to their initial investment.
4. Real Estate Yield
In real estate, yield measures the income generated by a property relative to its purchase price or current market value. It helps investors evaluate the profitability of rental properties and other real estate investments.
- Gross Rental Yield: This is calculated by dividing the annual rental income by the property’s purchase price.
- Net Rental Yield: This accounts for operating expenses (such as maintenance, insurance, and taxes) and is a more accurate measure of profitability.
5. Earnings Yield
Earnings Yield is the inverse of the price-to-earnings (P/E) ratio. It shows the percentage of a company’s earnings relative to its stock price and is used by investors to compare earnings with the price paid for the stock.
Importance of Yield for Investors
Yield is a critical metric for investors, particularly those seeking income-generating investments. Here’s why yield is important:
1. Measuring Income
Yield helps investors understand how much income they can expect from an investment, whether through interest (bonds), dividends (stocks), or rental income (real estate).
For income-focused investors, such as retirees, yield is a key factor in selecting investments that provide regular cash flow.
2. Comparing Investments
Yield allows investors to compare different types of investments on an equal footing.
For example, an investor can compare the dividend yield of a stock with the yield on a bond or the rental yield on a property to determine which offers the best return.
3. Assessing Risk and Return
Yield is often used to assess the risk and return of an investment. Higher yields typically indicate higher risk, as investors demand more return for taking on more uncertainty. Conversely, lower yields may suggest a safer investment with less potential for high returns.
4. Tracking Investment Performance
Yield is also a useful tool for tracking the performance of an investment over time. For long-term investors, monitoring yield changes can help assess how an investment’s income-generating potential has evolved.
Factors That Affect Yield
Several factors can influence the yield of an investment, including:
1. Market Prices
For investments like bonds and stocks, changes in market prices directly affect yield. For example, if a bond’s price increases, its current yield decreases because the fixed coupon payment represents a smaller percentage of the higher price.
2. Interest Rates
Changes in interest rates can impact bond yields and the yields of other fixed-income investments. When interest rates rise, new bonds offer higher yields, while existing bonds with lower yields may see their prices decrease.
3. Company Performance
For dividend-paying stocks, the company’s performance plays a significant role in determining yield. If a company increases its dividend payments, the dividend yield will rise, but if the company’s stock price increases faster than the dividend growth, the yield may decrease.
4. Inflation
Inflation affects the real yield (yield adjusted for inflation). If inflation rises, the purchasing power of the income generated by an investment decreases, potentially lowering the real return.
Conclusion
Yield is a fundamental metric for investors, providing insight into the income-generating potential of an investment relative to its cost or market value.
Interested in learning more VC related terms? Head over to our VC glossary!