Definition of yield
While there is no one yield definition covering every financial situation, generally the term yield refers to the rate of return on a given investment; this figure is usually a percentage and provides a measure of the profitability of that investment. Usually yield calculation involves comparing the interest or dividends produced by an investment by either its purchase cost, face value, or market value. Financial analysts calculate a number of different yields; each requires the use of a different yield formula.
Yield Calculation for Bonds and Treasury Securities
For bonds and Treasury notes and bills, yield is calculated in several different ways. Nominal yield refers to the percentage result derived by dividing the total annual interest by the face value on the security.
• Nominal yield = Total annual interest / face value of security
Current yield is calculated by dividing the total annual interest by the security’s current market value.
• Current yield = Total annual interest / current market value of security
The yield to maturity formula is much more complex as it involves compounding interest until the security’s date of maturity. This yield formula produces the rate of return on the initial investment for the entire life of the security and is derived by dividing the total expected rate of return on the investment from purchase to maturity by the initial purchase price and subtracting one.
• Yield to maturity = (Total compounded rate of return / initial purchase price)
The yield to maturity ratio is most often used as a predictive indicator of the probable overall return on investment expected from the purchase of fixed-interest securities.
Yield Calculation for Preferred Shares
Preferred shares provide stockholders with the promise of regular dividend payments. While the actual terms applicable to preferred shares of stock are arranged between the company and the investor, generally these payments are treated in a similar fashion as interest on a loan rather than as common stock dividends. The most common types of yield calculations for preferred shares are the dividend yield and the current yield; the dividend yield is figured in much the same way as the nominal yield of bonds.
• Dividend yield = Annual total dividend payments / face value of preferred shares
The current yield for preferred shares is treated similarly to the current yield for bonds and Treasury securities.
• Current yield = Annual total dividend payments / current market value of preferred shares
Yield Calculation for Common Shares
Because of the volatility of the stock market, most analysts calculate the yield of shares of common stock using their current market value rather than purchase price. This provides a more accurate assessment of the actual yield of the shares in question. The most common types of yield calculated for common shares are the dividend yield and the earnings yield. The dividend yield is the annual total of dividends paid per common share divided by the market value of the share.
• Dividend yield = Total annual dividends per share / market value of common share
Since not all earnings are distributed to shareholders as dividends, analysts also calculate the earnings yield of common stocks in order to determine their profitability. The earnings yield is derived by dividing earnings per share by the current market value of a share of common stock.
• Earnings yield = Total earnings per share / market value of common share
Because the different types of yield are used to assess different aspects of an investment, they cannot typically be compared with each other on a one-to-one basis. Essentially, yield is a measure of the rate of return on investments, and varies depending on the type of investment and the purpose for which the assessment was made.