Why is Yield Less Important than Yield on Cost When Dividend Investing

My favorite investment asset is my very small but growing dividend investment account.  When we finally move (circa 2014 at this point lol) I will be focusing a lot more energy and money on the account.  It is my hope that one day Future Evan and The Wife will be able to turn off dividend reinvestments and have a legitimate viable stream of income that has kept up with inflation since I am buying only stocks that have increased their dividend for over 25 years.  Obviously, past performance is not indicative of future returns, hopes, dreams or wishes.

What is Yield on Cost? How is that Different from Dividend Yield?

To understand what yield on cost is, one must understand what the dividend yield is first.  Investopedia defines the dividend yield as,

A financial ratio that shows how much a company pays out in dividends each year relative to its share price. In the absence of any capital gains, the dividend yield is the return on investment for a stock. Dividend yield is calculated as follows:

Dividend Yield

Makes sense, but what about the situation that I am hoping for? I purchase blocks of undervalued dividend stocks that then increase in stock price.  I bought the stock at a lower price so why would current yield matter? If I bought a stock at $30/share and it is paying a 3% yield and it goes up to $40 and is still paying a 3% yield…my yield is higher because I still only invested that original $30. Enter Yield on Cost.

Investopedia defines Yield on Cost as,

The annual dividend rate of a security divided by the average cost basis of the investments. It shows the dividend yield of the original investment. If the number of shares owned by the investor does not change, the yield on cost will increase if the company increases the dividend it pays to shareholders; otherwise it will remain the same.

It also becomes useful when discussing free dividend reinvestments since my original investment is still there, but now I have more shares that I obtained for free.  For example, I buy that same share at $30 that pays a 3% yield so I am able to obtain another .003 shares which throw off more shares…but I still only originally put in $30.

Yield on Cost attempts to quantify a no research reasons why I like mature dividend paying stocks that I missed in that post.  It is the idea that I am putting $X in today and in Y years I hope to be pulling that amount outevery year.

A very real example provided by Seeking Alpha a couple days ago (note the date on the post so stocks obviously change price every second):

If you’d purchased $10,000 worth of the stock back [Proctor and Gamble - PG] in 1982, three decades ago, and reinvested dividends, you’d have 8,964 shares of stock today. Each pays $2.25 per share, so your income would be more than $20,000 per year.

Drawbacks of Relying or Caring about Yield on Cost

Even if we look at the example from the Seeking Alpha article, it does not take into account inflation.  $10,000 in 1982 Could have bought you a decent house in most of the country now it won’t buy you a car.  That being said, I am sure it wouldn’t be too tough to figure out time of money costs.  So, if inflation is at 3% the value of the dollar would double every twenty years (Rule of 72, anyone?) so lets call our $10,000 really $40,000.  That would mean you are still getting $20K per year half of your “real” investment every year.  That is an income stream I’d buy any day!

I think the real draw back for me when it comes to yield on cost is that it is near impossible to follow, track and or calculate other than in 30,000 feet above examples like the one above.  With dollar cost averaging being the norm today I think it would be rare for a retail investor to plop down $10,000 on a single stock in a single purchase.  This leads you to tracking 100s of purchases and their reinvestment.

I don’t think I’ll ever quantify my yield on cost, but as a concept it makes sense to me and seems much more important to me than just plain yield.

5 Responses to Why is Yield Less Important than Yield on Cost When Dividend Investing

  1. I had read about this last week – seems like something that’s worth paying attention to when trying to build a large dividend income stream like you are.

  2. What if you take your cost basis and then divide by the number of shares held, then divide that into the annual yield? Isn’t that the number you’re looking for? I can’t remember who you’re using now but I remember you used to have a Sharebuilder account and they give you your cost basis right on the main summary page. You’d still have to look up the annual yield but wouldn’t take much to build a simple spreadsheet to take a closer look, unless I’m missing something.

      • I built a spreadsheet that pulls all of the relevant info from Yahoo (thanks to gummy-stuff.org for that) and calculates my YOC by dividing the annual dividend (per yahoo) by my calculated average cost. I just have to enter my activity. It is a work in progress, but pretty cool.

        I have my dividend portfolio in my Roth IRA at sharebuilder and I hope to start ramping up my contributions soon. I just need to figure out a way not to get killed on transaction costs.

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