Today I wanted to cover one of the most critical dividend stock metrics, yield on cost (YOC for short).
Rising YOC is one of the great benefits of owning dividend stocks, in particular one with good dividend growth. YOC is simply the current dividend rate divided by the price you paid for the stock. For example, if you bought a stock for $20 with a 5% yield ($1), and the dividend over time rose to $2, then your yield on cost would be $2/$20 or 10%. In other words, the return on your investment is rising over time! How many other investments can give you that kind of benefit? A dividend stock with zero dividend growth, while still better than one with no dividend, would never have an increasing YOC.
I’ll let the CEO of one of the great dividend companies explain it. Tom Lewis is CEO of Realty Income, ‘The Monthly Dividend Company’. He explains Yield on Cost here in some more detail. Read the whole thing for yourself. Here is a teaser,
A new income investment paradigm, therefore, is to find investments that pay high quality, increasing income, and keep them as long as they continue to produce a rising yield on cost over time. Once you’ve “got” this lesson, you’ll not only receive an A in the class, but you’ll also be able to build and maintain an income portfolio that is designed to last a lifetime.
Imagine buying a portfolio of dividend stocks, with 4% avg yield, and ten years later (with a 7.2% dividend growth rate), you’re making 8% on your original investment and ten years later you’re making 16% on your investment! And that is irrespective of the market price of the stock. This is one of the truly great powers of dividend growth investing. In can make you very rich over time.
Now, just a few more details. Many dividend investors, like myself, reinvest their dividends every time they get them. This complicates the YOC calculation a bit but not by much. With reinvested dividends the YOC is the current dividend divided by your weighted average cost basis. Every time you reinvest your dividend you have a new purchase price for those new shares which combined with your original purchases gives you a weighted average. Details on how to calculate this in detail can be found here. In general, as long as your dividend is increasing, your YOC will increase even with reinvested dividends.
So, while you’re searching for great high quality dividend stocks make sure to keep YOC in mind, in other words, make sure you balance current yield with solid dividend growth, and a rising YOC will help make your retirement a very bright one.
Full Disclaimer - Nothing on this site should ever be considered advice, research or the invitation to buy or sell securities. These are my personal opinions only.