The yield represents a measurement for cash flow that an investor receives on the amount invested in a security. Most of the time it is measured on an annual basis, even though it can be also measured as monthly or quarterly yield. Yield is expressed as a percentage based on the invested amount, current market value, or face value of the security. When computing yield for stocks, both price increases as well as dividends paid are taken into account. Let’s take a simple example.
Assume an investor purchases a stock at the price of 200$ per share and after a year he/she sells it for 300$. Additionally, the stock may pay a dividend, let’s say 4$/share during the year. To compute the yield, we would add the appreciation of the share price, the dividends paid (if existing), and we would then divide by the original price of the stock, therefore we would get:
(100$ + 4$) / 200$ = 0.52, 0r 52%
What does yield indicate?
Most of the time an increased yield indicates that the investors are able to recover greater amounts of cash flow on their investments. Therefore, a high yield is associated with higher income and reduced risk. However, this might not always be the case. A high yield can also be the result of a falling market value of the corresponding security, which basically decreases the denominator value from the formula, thus increasing the computed value of the yield. Therefore, an increased yield can also happen as a result of the corresponding price of the security going down.
Another behaviour to keep an eye on is when the dividends of the security are increasing (thus the yield increases as well), but the price of the security is not increasing (most of the time this behaviour indicates future cash flow problems, so investors should be on guard).