"Yield" is a common expression in Wall Street; and as with the word "security," sometimes its meaning is what an intelligent amateur would suppose, but often it is misleading.

On Bonds

Among the corporate and government bonds bought and sold in the stock market, sometimes the purchase price, the par value, and the maturity value are all the same amount. Suppose this amount is $1,000, and the annual interest is $40. This interest is at the rate of 4 per cent per annum on the par value, and in this case 4 per cent is also the yield, meaning the annual interest amount divided by the price.

But usually the purchase price on a bond is not the same as par or maturity value, and this difference gives two ways to figure yield. Suppose the current price of the bond is $800, whereas it will mature at $1,000. Ignoring the maturity value, we say the "current yield" is the annual in­terest, $40, divided by the price, which gives 5 per cent. But at maturity, this bond will have a value $200 more than its current price. The "yield to maturity" includes the pro­spective change in value as well as the annual interest. We skip the details of this calculation, because our purpose here is merely to show that for a bond the yield is a useful idea, with two different but definite meanings.

When a bond has a high yield, compared to other bonds, it means that for some reason the consensus of opinion in the market is more critical of this bond. Maybe there is doubt that interest and principal will be paid on time. Or maybe the issue is small, or the issuer is not well known, making it harder for a bond-owner to sell, if he should want to, before maturity. At present, the yield tends to be higher on a bond with a more distant maturity. And of course, if a bond is exempt from some taxes, especially Federal income tax, that causes it to sell at a higher price, thus lowering the yield.

On E bonds and other savings bonds issued by the U. S. Government, with rigid schedules of values and interest pay­ments, the yield has a peculiar meaning. On an E bond, semi-annual increases in redemption value take the place of interest payments. In the schedule announced in 1957, after a bond costing $75 has been held six months, its value rises $0.60. To adjust this to a twelve-month basis, we double the amount of increase, making it $1.20. This divided by the cost gives 1.6 per cent, which we can call either the an­nual interest rate, or the yield, on the purchase price, for the first six-month period.

When an owner continues to hold an E bond, at each semi-annual date the increase in value is greater than the first one, and the yield on cost rises accordingly. On a bond held to maturity, eight years and eleven months after pur­chase, the total appreciation on $75 cost is $25, equivalent to an annual interest rate or a yield to maturity of 3.25 per cent on the purchase price. For accuracy, we should add that interest or yield on E bonds is figured as being com­pounded semi-annually.

On Stock, What "Was the Yield?

On preferred stock, but rarely on common stock, the divi­dend may be uniform and reliable enough so that the current yield has somewhat the same meaning as on bonds. But the idea of a yield to maturity can be applied to stock only in the rare instance that the issue is scheduled to be closed out on a certain date.

On a typical common stock, the issuing company is not committed to paying a set rate of dividend in the future, not even one year ahead. So to obtain a definite figure for a yield, the statisticians go back to the total dividends paid last year, or in the latest twelve months, and divide this by the current price.

Wall Street commentators, in discussing the owning of stocks versus bonds, often make the unwarranted assumption that last year's dividend rate on stock will continue into the future, the same as interest on a bond can be expected to do. When the current yield on stock happens to be no higher than on bonds, these advisers say an investor should sell stock and buy bonds. They ignore the question of whether the stock may change in value or in dividend, or both.

But when you buy stock at today's price, obviously you won't receive last year's dividends. If the price of a stock is lower than formerly, quite possibly it is because the com­pany has cut the dividend rate, or is expected to. And a rise in price of a stock implies that dividends will increase. So what good is a yield figure, obtained by dividing last year's dividends by the present price?

Here is a different way of judging the yield on stock. As­suming that when a man buys stock he expects to keep it for quite a while, he is interested in what the dividends are likely to be during several future years. The past record in­terests him only as it shows a trend that may continue into the future.

At the end of 1957, each of the older mutual funds pub­lished a statement of the results obtained each year from a purchase of shares in that fund fifteen years earlier, at the end of 1942. From such a record of one large, diversified common-stock fund, we develop these figures of yield, as­suming that a shareholder reinvested his capital-gain distribu­tions but took his income dividends in cash. On shares bought at the end of 1942 income dividends in 1943 was 4.8 per cent of the cost. In each successive year they were larger than in the previous year. In the fifth year they were 7.0 per cent, the tenth year 10.9 per cent, the fifteenth year 15.7 per cent of cost. The increase is due largely to the rise in prosperity and inflation that tended to lift corporate-dividend rates generally during those fifteen years. Earlier, in the 1930's, the great depression had caused dividends gen­erally to drop.

Two mutual funds can be alike to the extent that each is a well managed, broadly diversified common-stock fund, and still the current yield on Fund A may be 1.5 per cent, and on Fund B 7.5 per cent, five times as much. Which fund is a better buy? It depends on what sort of results an investor wants. Fund B has chosen for its portfolio a group of stocks with high current yields. Fund A has picked stocks with low current yields—which is the same as saying that its portfolio contains stocks that are priced high in comparison to their dividends, the reason being that the market values of these stocks, or their dividends, or both, are expected to rise faster than those of other stocks.

Before buying shares in any mutual fund, a cautious in­vestor examines and compares the past performance of the fund on both dividends and change in market value over a period of at least ten years. The fifteen-year dividend record given above is for a fund whose investment policy lies be­tween the extremes of those with a high current yield and those emphasizing future growth.

To make sense, it seems to us that on common stock in­stead of the usual phrasing "What is the yield?" we must change the question to ask, "What was the yield?" That is, if a person bought the stock on a certain date and held it for so many years, what were the dividends figured as a percent of his cost? This interpretation of the question is illus­trated in the example a page or so above, of the trend of dividends during fifteen years on stock bought at the end of 1942.