What Is Yield
Yield is the returned income on an investment. This typically refers to income generated from interest or dividends. For the most part, yields are expressed in annualized terms. The two most common types of yields investors are familiar with are: bond yields and equity cash dividend yields.
Examples Of Bond Yields
Investors receive interest payments on their investment, known as a coupon. Coupon rates are fixed, based on the time of issuance and are paid on a specific schedule. Zero-coupon bonds do not pay a coupon; however, they sell at a discount to their value. Bond prices move inversely to yields.
Whenever you invest in a debt instrument like a bond, you also want to keep a close eye on inflation. The higher inflation gets, the higher yields go, and therefore, lowering your principal value of your bond investment.
Examples Of Yield From Cash Dividends
One method corporations use to make their company more attractive to investors is offering a cash dividend. This is cash paid out by the firm to its stockholders. It’s also another way for a company to to return capital to its shareholders.
Source: Yahoo Finance
AT&T (NYSE: T) offers its investors an annual dividend of $2 per share. Now, if you take that number and divide it by the current stock price, you’ll get the annual dividend yield, which is 5.44% based on the chart above.
Source: Yahoo Finance
Exxon Mobil Corporation (XOM) pays investors an annual dividend of $3.08 per share owned. Based on the closing price of the chart above, the annual dividend yields 3.97%
Let’s say bought 100 shares of a fictional company called Evil Corp. Evil corp pays investors an annual dividend of $5 per share. With the stock trading at $100 that equates to annual dividend yield of 5%.
Let’s say the firms fundamentals worsen throughout the year, and its stock price plummets 40%. It’s true, a 5% annual yield is attractive to most investors. However, that did not come without risk. And with the stock trading at $60, the annual dividend yield is even higher, at 8.3% but anyone that invested at $100 would be down a significant amount on their position.
A high dividend yield is attractive but that doesn’t mean there isn’t risk. That said, it should never be a primary factor for selecting a stock. After all, the company can always change the dividend policy, cut it, or even suspend it.