The Diary of Different Yields

Earnings and dividend yields are important metrics for evaluating stocks. SEC yields net dividend and interest income against fund fees, in order to determine income potential for the next year. Bonds are evaluated on a yield-to -maturity, yield-to-call, and yield-to-worst basis.

Not All Stock and Bond Yields are Created Equal Following the Great Financial Crisis (GFC) of 2008, balanced investors were not much concerned about ‘yields’ – the income generated by a security, expressed as a percentage of its’ market price or face value. This was due to the equity market dramatically outpacing the bond market. The stock market has been dominated by growth stocks that did not have much if any dividend yield, and bond yields were low due to the Fed’s zero interest rate policy post the GFC.

Fast forward to present day, and the calculus has changed: bond yields are no longer pinned near zero. Thus, stocks now must compete harder for investor portfolio allocations, given the increasing attractiveness of current bond yields. However, it is easy to get lost in all the jargon when trying to compare various security yields…especially as they tend to measure subtly different things that may not be immediately apparent from the names. We intend to provide a roadmap of the different measures of yields that we analyze when making asset allocations between stocks and bonds across our Advantage and Custom Portfolio Solutions strategies. It is important to understand that all yields are not created equal…but we find all of them useful in helping to determine the attractiveness of a security.

Stocks are Total Return Vehicles…and Dividends Definitely Matter! When most investors think about stocks, they often immediately focus on price appreciation potential, and give less thought to the income-generating qualities. However, it is the combination of the two that provides the total return for stocks, especially when they are reinvested. A study from our friends at NDR suggests almost 40% of US stocks’ long-term total return has historically come from the compounding of dividends (Chart, below). RiverFront uses total returns when estimating the long term expected returns for stocks and bonds and thus their relative attractiveness.

Earnings Yield vs. Dividend Yield: Two Very Different Measures, For Different Stock Investment Styles Depending on the objective of the equity investment, we tend to look at several different yields to determine if a stock is under or overvalued. Yields that we explore for equities are the earnings and the dividend yield. An earnings yield (E/P) is the inverse of the price-to-equity ratio (P/E) for a stock or equity index like the S&P 500. As portfolio managers, we compare the earnings yield to the risk-free rate 10-year Treasury bond, as a useful input in determining the valuation between stocks and bonds. When we are seeking income in addition to price appreciation from stocks, the yield we explore is the dividend yield. By dividing the annual dividend paid per share by the current price of the stock, we can determine the dividend yield. Companies with higher dividend yields can potentially serve as fixed income substitutes from an income perspective. If the dividend yield is close to or higher than the risk free 10-year Treasury bond, we may be willing to take the additional risk of buying equities, given the upside price appreciation potential. In our Advantage and ETF Advantage strategies where we use ETFs to invest in stocks, the distribution yield is similar to the dividend yield. By taking the most recent cash payment and annualizing it and then dividing it by the current price of the ETF gives us the distribution yield. While this yield is helpful, industry standards point us to the SEC yield, which nets the dividends and fund fees over the last 30 days, in order to forecast dividend income for the next year.