Thinking about investment yields? Look forward

When calculating how much your equity-based investments are earning, don’t focus on the rear-view mirror. Most investors have a point-in-time mentality when it comes to thinking about the yield on their investments. They remember what they paid for the investment and what the yield was at the time of purchase, but they often forget to recalibrate their yield outlook over time.

For example, Bob remembers that 3 years ago he purchased 1,000 units of the private real estate trust at $10 a unit and since it had an annual distribution of $0.5 at the time of his purchase, his annual yield on the investment was 5%.

However, Bob needs to look at the investment’s current distributions to ascertain if his original 5% yield has changed. For instance, if the annual distributions on Bob’s units had increased to $0.55 in year 2, and to $0.6 in year 3, the current yield on his investment at the end of year 3 would be 6% or 20% higher than what it was originally.

This “point-in-time” investment focus also comes into play when investors are considering adding equity investments that pay out a distribution to their portfolio. In most cases, the investor spends time to understand the current yield that the investment is paying, but very little time on the potential for that yield to increase over time. By asking the following simple questions, an investor should be able to ascertain the likelihood that the investment will increase its annual distribution.

  • Does the investment have a history of increasing its annual distribution? If so, how often and by how much have annual distributions increased in the past?
  • Where is the investment in terms of its natural life cycle? Is it in its growth phase, stability phase or deterioration phase? The further along an investment is in its life cycle the less likely it will be able to continue increasing its distributions.
  • Are the cashflows that the investment receives from its underlying business stagnant or can cashflows be increased by raising prices (in the underlying business) without reducing demand?
  • Will the underlying assets associated with the investment appreciate or depreciate over time? If they have historically appreciated over time, then this could provide another source of potential gains that can be redistributed back out to investors.

Although this list of questions is not exhaustive—it can be helpful in determining if an investment has the potential of increasing its distributions over time and, by extension, the investor’s effective yield.