I’ve seen the term “dividend yield on cost” come up a couple of times recently. I’m new to looking at dividend investing, so I hadn’t come across it before. I’ve been focused on growth. My investing has almost always been in a retirement account and with very broadbased ETFs. I consider myself a Boglehead. It’s sad about Jack Bogle passing away last year (By the way, I have found that Dead or Kicking is a fast-loading site to get quick answers on well… the obvious.)
I don’t expect that will change any time soon, but I’m starting to look more at qualified dividends for taxation purposes.
The concept of a dividend yield (or any other yield) is something that (I think) most investors understand. For example, if a bank account pays you 1% interest, it’s a 1% yield. You give them $10 for a year and you get 10 cents. It doesn’t sound much with such small numbers, but through the power of compound interest it can add up to a lot of money over time. The concept of a dividend yield isn’t different than an interest yield except that it involves the money a company pays you for owning its stock. You can even reinvest dividends just like compound interest in a bank account.
That’s enough of a primer (or review depending on your knowledge) on what yields are. Now we can get to:
What is “Yield on Cost”
This is simply what you paid to own the stock in the first place. Let’s say that 10 years ago you paid $100 to buy a share of a company called “Acme.” At the time, Acme paid a 3% dividend yield. You made $3 a year. To make the math simple, we’ll pretend that you didn’t reinvest it. Instead you bought some Pokemon cards at the local 7-11.
Ten years later (now), Acme is selling at $200. Using the rule of 72 that is entirely possible – it would have grown 7% a year over each of those 10 years. Let’s also assume that Acme still pays out the same 3% dividend yield. However, 3% of $200 is $6 now. Your effective dividend is $6 on a cost of $100. So your yield on cost is 6%. Of course 10 years of inflation eats into the buying of that, but it is still nice growth.
Here’s a real world example of a stock that I own: IBM. In late October 2018, IBM accounted it was acquiring Red Hat. It sent the stock tumbling from $150 to around $115. IBM has paid a very strong dividend for quite a long time. At the time it was paying around 4.2% (roughly $6.28 a share a year). With the stock tumbling to $115, the yield would have jumped to 5.4%. Investors were likely concerned about IBM’s ability to pay its dividends given the acquisition.
Today, only about 14 months later, IBM is back to around $150 a share. They’ve even raised the dividend a bit. If you had bought IBM during that time, your yield on cost would be around 5.65% ($6.48 on a cost of $115). Investors buying it today, enjoy only a 4.3% yield. In this case, a timely purchase significantly increased the yield on cost so quickly that inflation is mostly irrelevant.
There are a couple of lessons to take away here:
- Buying quality companies with solid yields on dips can pay off.
- Buying the same types of companies and holding on to them for a long time can pay off as well.
The question is often, what counts as a great company? I like IBM, but a lot of professionals do not. I may be biased by love for their old PCjr that helped teach me how to program.
Strong companies that have a long history of dividend growth are often called dividend kings. The best place I know to get great updated information on these companies is Sure Dividend’s newsletter. It does cost some money, but for people who are investing significant amounts of money, it isn’t much and can save investors a ton in research. That link to the Sure Dividend newsletter has a special discount rate. (In full disclosure I make a few dollars if you sign up for it.)
Final Thoughts on “Yield on Cost”
I know that this may get confusing. Sometimes reading a “wall of text” isn’t the best way to learn. I found a 4-minute YouTube video with an explanation at least as good as mine:
I don’t know the makers of the video, so I can’t vouch for whether they are good financial advisors. However, if you are a visual learner, this may be right for you.
At the end of the day, the biggest thing to know is that investing money today can buy a big income stream down the line.