What Do We Understand By ‘Annual Yield’?

Understanding Annual Yield: Yield generally refers to the dividend, interest or returns an investor gets from a security like a stock or bond, and is usually reported in annual numbers. Thus, annual rate of return that is based on compounding interest is generally defined as ‘annual yield’.

When talking in terms of equities, annual yield or dividend yield is the annual dividend taken against the share price. Further, the annual dividend may be the dividend paid over latest financial year or sometimes dividend paid over last four quarters. As per the above definition, the yield is inversely proportional to the share price of a company. In such scenarios, an investor can devise a suitable income strategy and develop a portfolio based on yields of a company. Sometimes, investors prefer stocks with higher annual yields to set a continuous stream of dividends. Then, strategy to focus more on stocks that have sustainable yields backed by resilient fundamentals comes into picture. For example, ASX listed stocks such as Commonwealth Bank of Australia (ASX:CBA), BHP Billiton Limited (ASX:BHP), and Magellan Financial Group Limited (ASX:MFG) with dividend yields of 5.95%, 5.14% and 5.06% become some secular income stocks to have. Then high yielding stocks like WAM Capital Limited (ASX:WAM) with dividend yield of 6.95%, also stay under investors’ radar.

It is also to be understood that dividend yields get defined by payouts in relation to profit or earnings; and can come at the cost of growth. That is many companies, which may have lower dividend yields may actually be investing in business for growth. So, in some cases investors can make enormous money through appreciation in share price instead of dividends primarily. Accordingly, this brings the need to balance the investment portfolio such that investors can benefit from dividends in case of income stocks and can also leverage from growth of certain stocks. Having said this, many indices still have dividends forming a large chunk of returns profile. Thus, a close call on companies that are mature and resilient in terms of business can be taken to benefit from the dividend profile. It is also sometimes true to say that high dividend yields can prove to be good investments in a bear market.

In general parlance and not just equities, the annual yield can standardize interest rates into an annualized percentage and contributes to the return from any investment. Earlier, double-digit annual returns were quite common but with changing economic scenario, the yields have fallen from their benchmark numbers with many changes being witnessed like capital growth for bonds and growth assets have come into picture.

How to predict Medium term return potential: The medium term growth should be based on current yields of different assets and assumptions made on capital growth. For example, equities run on a model wherein dividend yields can be looked upon with nominal GDP growth (to reflect growth for earnings and capital) and this can decipher the medium-term returns. Some investors base current valuations of equities on this simple methodology. For property, rental yields and inflation trends become key to the capital growth. Unlisted infrastructure is based on average yields and capital growth in view of inflation; and bonds base the medium-term returns on five-year bond yield.

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