One my favorite bond analysts, Rom Badilla of Bondsquawk.com, recently recommended the high yield bonds of Sandridge Energy, a large producer of oil and natural gas. However, a person not very familiar with technical terms of the bond market might easily get confused about how much these bonds actually yield.
The word “yield” can have many different meanings. When Rom uses the word, he usually means yield to worst. When you’re trying to compare different bonds, yield to worst is the best (and lowest) measure of yield. The SandRidge Energy Bonds (CUSIP 80007PAL3) currently have a yield to worst of 5.83%
I will be using Sandridge Energy bonds as way of illustrating the different types of yields but, first I want to mention why Rom is bullish on these bonds.
- Management is predicting 18% increase in oil and gas production next year.
- A major asset sale could lead the company to debt load being cut in half.
- Its yield is a little higher than similar types of energy companies.
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The are four commonly used yield related terms for bonds: coupon rate, current yield, yield to maturity and yield to worst. Here’s each for Sandridge Energy’s bonds.
Sandridge Energy Bonds Yield Measures
|Yield To Maturity||7.02%|
|Yield To Worse||5.83%|
The coupon rate is the interest paid by the issuer. In the case of these Sandridge Energy bonds, the coupon rate is 8.75%. If one owned $1000 of these bonds, one would receive $87.50 of interest per year, usually in two installments. The market value of the bonds does not affect the amount of interest that is paid or the coupon rate.
The current yield is interest on the bonds divided by the market price. The current market price for these Sandridge Energy bonds which are worth $1,000 at maturity, is actually higher than $1,000. It’s $1095.00. So the current yield, would be $87.50 / $1095.00 = 7.99%
For a video which describes these key concepts in greater detail, click here.
Yield to maturity is more like your expected return on investment if the bonds are held to maturity. These bonds will mature on January 15th, 2020. You can think of yield to maturity as the current yield adjusted for the gain or loss of the bonds value. In this case, the market price of these Sandridge Energy bonds is $1095.00. However, the holder of the bonds will only receive $1000.00 at maturity, causing a loss of $95. As a result, the return on these bonds will be lower than the current yield. The yield to maturity on these bonds is 7.02%
Yield To Worst is similar to yield to maturity, however, takes into account that some bonds are called, meaning paid off the by issuer prior to maturity. (you can learn more about callable bonds here.) In the case of these Sandridge Energy bonds, they can be called on January of 2015 at a price of $1043.75. As the bonds will not have time to generate much interest (in terms of dollars) if called, the loss of value of the bonds will have an even bigger impact on return. In this case, the yield to worse will be 5.83%.
Does a yield of 5.83% make Sandridge Energy bonds a bad investment? No. But I would be very disappointed if I bought them expecting an 8% yield and got only 5.83%.
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