What is Yield?
Yield can be calculated using the following formula:
Example of Yield
For example, say that an investor buys a stock for $100.
After holding it for a period of time, the investor earns $5 in dividends and sells the stock for $120.
The realized returns are equal to the earned dividends plus the appreciation in share price, or ($5 + $20) / $100 = 25%.
Taking Caution with High Yield
While a high yield means greater returns for investors, it must be interpreted carefully.
For example, a sudden increase in the yield of a stock could indicate a falling stock price.
This decreases the denominator in the yield equation and so raises the resulting percentage.
An increased yield can also result from an increase in dividend payments.
If this does not correspond to an increase in cash flow, the issuing company may have difficulty maintaining future payments.
Likewise, since bonds carry with them the risk of default, a higher than average yield could be because of a higher than average risk.
Many companies that issue risky bonds also issue them with a high yield, or coupon rate, in order to increase the appeal to risk averse investors.