There is a lot of talk about bond yield in the news now days, so I wanted to take a minute to talk about yield. We recently talked about interest rates and how low-interest rates meant that borrowing money was cheap, but it also means that you get very low-interest on your savings account.
This rate of return. The amount of money you get paid annually to invest in something is called yield. It is different from capital gains which are speculative in nature. Yield is clearly defined before you invest in something. If I buy a stock and it goes up in price, my profit is a capital gain, not yield. I had no guarantee ahead of time what that profit (or loss) would be.
My regular readers know I am a big fan of dividend paying stocks. The reason is yield. These stocks have a clearly defined dividend yield. They tell me ahead of time how much money they are going to pay me yearly in dividends and based on the current price of the stock, what those payments represent as a percent of my purchase price.
The thing to understand about yield is that it is inversely related to the price of the asset. If the asset price goes up, the yield goes down and vice versa. Because asset price is based on the popularity of the asset, the yield is also inversely related to how many people want to buy that asset. Confused yet?
Let’s say you were a country that issued bonds that cost $100 and paid an annual yield of $3.00. So anyone who bought those bonds would get a 3% yield (rate of return) on those bonds. Now if this country started having financial trouble, fewer people would want to buy those bonds, so the price might fall to $50 but they still pay $3.00 annually, so the yield would jump to 6%.
$100 bond paying a 3% yield = $3.00 annually.
$50 bond paying a 6% yield = $3.00 annually.
The higher a country’s bond yield, the worse that country is doing. The lower the country’s bond yield, the more stable that country is.
Did you know Germany recently sold bonds that had a yield of negative 0.0122 percent? People were so scared of losing their money that they were willing to pay to invest in the relative safety of German bonds!!
The Wall Street Journal: German yields South of zero.
Canadian Performer’s Money: Interest rates.
Here’s a man with a sexy New Zealand accent…
A major point between bond and dividend yields are the expectation. Bond yield have to be paid, by the issuer. The only way of not paying is default, or solvency, which is obviously, the last resort. If this would happen, the bond holders, get first pick at the company’s carcas. The issuer can not change the bond for any reason.
For a dividend, the amount paid, is completely optional for the company. There is no guarantee. If they need some cash, they can cut the dividend completely, of just a partial cut. If this happens, they are usually punished by investors, with a share price drop, but they still can do it. Manulife would be an example. The dividend stream is not guaranteed.
Great points. Garth Turner also reported this week: “For the first time in six decades, dividend-paying equities are handing investors bigger returns than bonds”.
Well I understood your example… and I watched the video. The examples really help but so would a test to make sure I get it lol..it’s’ easier for someone like me who is trying to understand from the ground up. Thanks for doing this. Cheers Mr.CBB
So what CandianMDInvestor is saying is that because you like to buy the divident paying stocks it doesn’t necessarily mean you will get that money. The company can turn around and take those dividends and use them if they want to instead of paying out. If that happens the investors (you) would drop the share price… ( how does that happen?)
Let’s use Le Chateau as an example. They paid a good dividend, then got in financial trouble. The stock dropped in price causing the dividend to go even higher. A few months later they stopped issuing any further dividends, because they couldn’t afford to anymore.
That is why one of the first thing we look at when analyzing a stock is it’s ability to continue it’s dividend payout. We look at a metric called “dividend payout ratio”. That shows us what % of their profit are being paid out in dividends. We might also look at how many years they have paid a steady raising dividend.
Fortis Inc. is one of my favourite stocks and has raised it’s dividend 38 years in a row.
Bonds are debt issued by a company so they can expand their business. You lend the company money and get a set % back in quarterly payments and at maturity get the whole amount you lent them back. If the company were to go bankrupt the bond holders would be paid back first as it is an outstanding debt.
When you buy stock of a company, the company really owes you nothing. You may have bought stock that the guy down your street was selling on the open market. It has nothing to do with the company in a direct way. The price you agree to buy and sell stock may effect the stock price in the way supply/demand work though. If enough people sell and the share price drops, then the company will be effected as their market cap shrinks.
MD Investor… points I missed?
@CBB…RE: share price drop. Yes, Troy got it right, it is the issue of supply & demand. Many, if not most who invest in a stock, with a moderate or high yield dividend, want the dividend to be there. They need it for income, might be seniors, etc. If the dividend is dropped, these people will go elsewhere. party’s over!! If enough sell, the demand is less, and eventually price drops.
If enough institutional investors head for the doors, it may drop quickly. For example, a large hedge fund could hold millions of shares. Once they exit, panic starts,and it spirals.
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