What Is Yield on Cost? A Key Investment Metric

What Is Yield on Cost?

Yield on Cost (YOC) is a performance metric that calculates the dividend yield of an investment based on its original purchase price. Unlike the more commonly cited current dividend yield, which uses the stock's current market price, YOC measures the return on your initial investment. This provides a personalized measure of how much income an investment is generating relative to what you paid for it.

For a practical example, imagine you purchased a stock five years ago for $20 per share, and it currently pays an annual dividend of $1.50 per share. Your Yield on Cost would be 7.5% ($1.50 / $20). If the stock's current market price has risen to $50, its current dividend yield would only be 3% ($1.50 / $50). This demonstrates how YOC can highlight the growing income stream from a long-term investment.

How It Works

The mechanics of Yield on Cost are straightforward. The formula is:

YOC = Current Annual Dividend per Share / Original Cost per Share

To calculate this, you need two key pieces of information:

• Current Annual Dividend per Share: This is the total dividend paid out by the company over a year for each share owned.
• Original Cost per Share: This is the price you paid to acquire the stock, also known as your cost basis.

As a company increases its dividend over time, your Yield on Cost will also increase, assuming your original cost remains the same. This is because the numerator (the dividend) is growing while the denominator (your cost) is fixed. This dynamic is what makes YOC a powerful metric for long-term dividend growth investors.

It's important to note that if you purchase additional shares of the same stock at different prices over time, your average cost basis will change, which will in turn affect your YOC calculation.

Why It Matters for Dividend Investors

Yield on Cost is a particularly valuable metric for investors following a dividend growth strategy. Here's why:

• Highlights the Power of Compounding and Dividend Growth: YOC clearly demonstrates the benefits of investing in companies that consistently increase their dividends. As dividends grow, the return on your initial investment grows as well, often outpacing the stock's current yield.

• Provides a Long-Term Perspective: While current yield offers a snapshot of a stock's income potential today, YOC provides a historical perspective on how your investment has performed over time. This can be a significant motivator to stay invested for the long haul.

• Measures the Success of Your Investment Decisions: A rising YOC is a good indicator that you've chosen a company with strong fundamentals and a commitment to rewarding shareholders. It validates your initial investment thesis.

• Shifts Focus from Price Fluctuations to Income Generation: By concentrating on the growing income stream as reflected by YOC, investors can be less concerned with short-term market volatility and more focused on their long-term financial goals, such as generating a reliable passive income stream.

Real-World Example

Let's consider a hypothetical investment in a well-established company known for its consistent dividend growth. Suppose an investor, Sarah, bought 100 shares of Company XYZ ten years ago at $50 per share. At the time, the annual dividend was $2.00 per share.

• Initial Investment: 100 shares * $50/share = $5,000
• Initial Annual Dividend Income: 100 shares * $2.00/share = $200
• Initial Yield on Cost: $2.00 / $50 = 4%

Over the next decade, Company XYZ performs well and consistently raises its dividend. Today, the annual dividend has grown to $5.00 per share, and the stock price has appreciated to $120 per share.

Let's look at Sarah's investment now:

• Current Annual Dividend Income: 100 shares * $5.00/share = $500
• Current Yield on Cost: $5.00 / $50 = 10%
• Current Dividend Yield: $5.00 / $120 = 4.17%

As you can see, Sarah's Yield on Cost has more than doubled to 10%, showcasing the significant growth in her income stream relative to her initial investment. A new investor buying Company XYZ today would only receive a 4.17% yield. This example powerfully illustrates the advantage of long-term dividend growth investing.

Common Mistakes to Avoid

While Yield on Cost is a useful metric, investors should be aware of some common pitfalls:

• Confusing YOC with Current Yield: It's crucial to remember that YOC reflects the return on your original investment, while current yield reflects the return at the current market price. When making new investment decisions, comparing the current yields of different stocks is more appropriate.

• Ignoring Total Return: A high YOC is attractive, but it shouldn't be the sole factor in evaluating an investment. A stock with a high YOC might have experienced significant price depreciation, leading to a poor total return (income + capital appreciation). It's essential to consider both income and capital growth.

• Emotional Attachment to a High YOC: Investors can sometimes become reluctant to sell an underperforming stock simply because it has a high YOC. If a company's fundamentals have deteriorated and its future dividend growth is in jeopardy, it may be wise to sell, even if the YOC is impressive. The proceeds could potentially be reinvested in a company with a lower current yield but better growth prospects, ultimately leading to higher future income.

• Not Accounting for Reinvested Dividends: If you are reinvesting dividends through a Dividend Reinvestment Plan (DRIP), your cost basis will increase over time. This will impact your YOC calculation. It's important to track your adjusted cost basis accurately.

How to Use Yield on Cost in Your Strategy

Incorporating Yield on Cost into your investment strategy can provide valuable insights and help you stay focused on your long-term goals. Here are some practical tips:

• Track Your YOC Over Time: Regularly monitor the YOC for each of your dividend-paying stocks. A steadily increasing YOC is a positive sign of a healthy dividend growth investment.

• Use YOC as a Motivational Tool: Seeing your YOC grow can be a powerful motivator to stick with your long-term investment plan, especially during periods of market volatility.

• Combine YOC with Other Metrics: Use YOC in conjunction with other financial metrics like the dividend payout ratio, earnings per share growth, and free cash flow to get a complete picture of a company's financial health and its ability to sustain and grow its dividend.

• Leverage Technology to Track Your Portfolio: Manually calculating and tracking YOC, especially with reinvested dividends, can be cumbersome. Tools like DripEdge can simplify this process. DripEdge is a dividend portfolio tracker and snowball calculator that can help you monitor your dividend income, track your YOC, and simulate your future passive income. By inputting your holdings and purchase prices, you can easily see how your dividend income and Yield on Cost are evolving over time, allowing you to make more informed decisions about your dividend growth strategy.

FAQ

Is a higher Yield on Cost always better?

A higher Yield on Cost is generally a positive indicator that your investment has performed well in terms of dividend growth. However, it's not the only factor to consider. A stock with a very high YOC might have a low current yield, meaning that selling it and reinvesting in a stock with a higher current yield could generate more immediate income. It's essential to look at the bigger picture, including the company's future growth prospects and your overall financial goals.

How does Yield on Cost differ from Total Return?

Yield on Cost specifically measures the income generated by an investment relative to its original cost. Total Return, on the other hand, is a more comprehensive measure of an investment's performance, as it includes both the income generated (dividends) and the change in the investment's market value (capital appreciation or depreciation).

Should I use Yield on Cost to decide which new stocks to buy?

No, Yield on Cost is a backward-looking metric that reflects the performance of your existing investments. When deciding on new stocks to purchase, it is more appropriate to compare their current dividend yields, as well as their dividend growth history, payout ratios, and overall financial health. The current yield will give you a better indication of the immediate income you can expect from a new investment.

Disclaimer: The information provided is for educational and informational purposes only and does not constitute financial, investment, or legal advice. DripEdge is not a registered investment advisor. Past performance does not guarantee future results. Always do your own research or consult a qualified financial professional before making investment decisions.