Investment Yield in the decision-making process
The investment yield available from any given asset, helps investors determine the appropriate tactic in relation to allocation of investable funds to that asset. The decision could be whether to retain, to acquire, to vary the holding of that asset. When the allocation to an investment is being contemplated, the yield will be a factor in deciding whether or not to purchase. Specifically, the cashflow that will arise from the anticipated yield will be prominent in the decision-making of the investor.
Investment yield is only one of the characteristics of assets that is reviewed by investors: and it is considered in the context of investment risk associated with the particular asset. In this case the risk is the sustainability of the yield at a given level or range; and the certainty that it will be delivered according to schedule or on a timely basis.
What is investment yield?
Investment yield can be defined simply as the earnings received/ receivable from an asset in which financial interest has been invested. It is usually expressed as a percentage that relates to the annual return on a cost basis of the asset from which it is derived. The cost basis may be its original cost, its market value at a chosen point in time – or the face value of the security. Note: investment yield is different from the investment return from an investment in that the return includes any capital growth/ loss in its calculation.
Factors involved in calculating investment yield
Different asset classes may have yield expressed in slightly different ways: two of them that are universal are –
- Cost yield; and
- Current (value) yield,
where cost yield is an expression of the current annual earnings as a percentage of the original holding cost of the asset; and current (value) yield expresses the same earnings as a percentage of the current market value of the asset.
It is worth noting the relationship of earnings and asset value in the ‘current yield’ expression. For such any asset, if the earnings are unchanged but the yield is said to be higher, it indicates that the market price of that asset value has fallen. On the flipside, if the yield is seen to have fallen, then the value of the asset (the market price) has increased. This relationship becomes helpful when considering the allocation to an existing asset, compared with the acquisition of an alternative asset.
A dividend paid on an equity (share) investment is often expressed in yield terms, as a percentage of the current market value of the share. If you are following a share then; and notice that the yield percentage quoted is changing there are two matters to be aware of –
- The earnings base used in this calculation is the dividends paid for the prior twelve months; and
- The share price changes almost daily.
This means that you will need to undertake some research as to the anticipated future dividend before calculating what the yield will be for your situation if you invest at the current market price. [Note also that the yield is expressed in relation to the cash dividend received: if the dividend imputation credit is available to you, it will actually increase the yield available to you in each of the scenarios.]
Investment Yield calculation – a worked example
By way of an example then, let us assume that you bought BHP some time ago and you have it in your portfolio at a cost base of $40. For simplicity let us also assume that the annual dividend for last year was $5, but that the current share price quote is $35. These numbers will give us –
- A Current yield of [($5/ $35)x100]% = 14.28%, but
- A cost yield of [($5/ $40)x100]% = 12.5%
If however we find that the forecast dividend for the coming year is going to fall to $4 because of higher operating costs of lower resource prices (such as coal or iron ore), then the above results change to –
- A current yield of [($4/ $35)x100] = 11.4%, and
- A cost yield of [($4/ $40)x100] = 10%!
This will usually lead to investors bidding the stock lower if this yield is not considered acceptable for the other risks associated with holding that share (and may explain in part at least, why the share price has fallen from $40 to $35).
Another issue that can complicate this area of analysis is whether or not the investment portfolio is leveraged, or geared (i.e., utilising borrowed funds). This is a complex area of advice and information about it can be read in other articles in the Library on this website.
When bond investors discuss yield they also take into account another valuation, but we won’t seek to confuse the matter any further. If you have an interest in this aspect, please read “Investopedia explains Yield” (where you will read about ‘yield to maturity’); and “Understanding Bond Yields”, which gives some discussion about the movement on Bond prices.
In the environment of ‘lower returns for longer’, our investment committee has been concerned that equity prices (sharemarket prices) have been climbing in pursuit of yield because of the lower interest rates prevailing, rather than because of the fundamental profitability of the industrial enterprises driving the economy. A noted Australian economist (Dr Shane Oliver, AMP Capital) has commented very helpfully about this process (and the situation as it is in Australia at this late stage in 2013) and we have linked to his article for your interest: “The search for yield and return – has it gone too far or is there more to go?”
The experienced advisers at Continuum Financial Planners Pty Ltd work with their investor clients to determine the investment strategy that will bring an outcome in their best interest: ‘we listen, we understand; and we have solutions’ to the wealth management challenges you face – including dealing with the management and expectations around investment yield. Call us on 07-34213456; or, using the Contact Us facility, arrange a meeting to see how we can work together to achieve your goals.
(First written in November 2013 at the request of a client, this post has been refreshed in May 2018.)