Yield

Yield is the income return you get from an investment, much like the fruit you harvest from a tree you've planted. It's usually expressed as an annual percentage of the investment's cost or its current market value. Think of it as the cash your investment puts in your pocket while you own it. This is fundamentally different from a capital gain, which is the profit you make from selling an investment for more than you paid for it. For investors, particularly those following a value investing philosophy, yield is a critical measure of an asset's performance and attractiveness. It's most commonly discussed in the context of stocks (through dividends) and bonds (through interest payments), providing a steady stream of income and a reward for your patience. A healthy yield can be a sign of a robust and stable asset, but as we'll see, not all yields are created equal.

The term 'yield' isn't a one-size-fits-all concept. Depending on the asset and what you're trying to measure, you'll encounter several different types. Understanding these distinctions is crucial for making smart comparisons and avoiding common investment traps.

This is the rockstar of yields for stock investors. The Dividend Yield shows how much a company pays out in dividends each year relative to its stock price.

• The Formula: Dividend Yield = (Annual Dividends Per Share) / (Current Price Per Share)

For example, if a company's stock trades at $100 per share and it pays an annual dividend of $4 per share, its dividend yield is 4% ($4 / $100). For value investors, a stable and growing dividend yield can indicate a financially healthy, shareholder-friendly company. The great Benjamin Graham saw dividends as proof of a company's real profits. However, be cautious of an unusually high dividend yield. This could be a yield trap, where the yield looks high because the stock price has plummeted due to underlying problems. The company might be on the verge of cutting its dividend, leaving investors with both a loss of income and a fallen stock price.

For bonds, yield is the central measure of return. Because a bond's price can fluctuate on the open market after it's issued, there are a few key ways to look at its yield.

This is the simplest, but least useful, yield. It's the fixed interest rate stated on the bond, paid annually based on the bond's face value (or par value). If you buy a new $1,000 bond with a 5% coupon, it will pay you $50 per year. Its coupon yield is 5%. This number never changes, regardless of what happens to the bond's market price.

This is a more practical, real-time measure. The Current Yield calculates the return based on what you would pay for the bond today.

• The Formula: Current Yield = (Annual Coupon Payment) / (Current Market Price)

Let's take our $1,000 bond paying $50 a year. If interest rates rise in the broader economy, new bonds will offer better rates, making our 5% bond less attractive. Its price might fall to $950. The current yield is now $50 / $950 = 5.26%. This illustrates a fundamental rule of bonds: When bond prices go down, yields go up, and vice versa.

This is the holy grail of bond yields. The Yield to Maturity (YTM) is the total return an investor can expect if they buy a bond and hold it until it matures. It's the most accurate measure because it accounts for:

• The bond's current market price (what you pay).
• The annual coupon payments (the interest you receive).
• The face value (the amount you get back at the end).
• The years remaining until maturity.

YTM gives you a complete picture of your potential return, making it the preferred metric for comparing different bonds.

For a value investor, yield isn't just a number; it's a powerful tool and a guiding principle.

• It Pays You to Wait: Value investing often requires patience as you wait for the market to recognize an asset's true worth. Dividends and interest payments provide a tangible cash return during this waiting period.
• A Barometer of Health: A company with a long history of paying, and ideally increasing, its dividend demonstrates financial discipline and a commitment to rewarding shareholders.
• The Magic of Compounding: As the legendary Warren Buffett has demonstrated, reinvesting your yields can ignite the power of compounding. Reinvested dividends buy more shares, which then generate their own dividends, creating a snowball of wealth over time.
• A Valuation Reality Check: An asset's yield can be compared to other investments to gauge its relative attractiveness. For example, comparing a stock's dividend yield to the yield on a government bond (often considered a risk-free rate) helps you assess if you are being adequately compensated for the extra risk of owning the stock, a concept related to the equity risk premium.