Yield on Cost

Yield on cost (YOC) is an indicator of dividend yield, which can be obtained by dividing the current dividend on a stock by the price originally paid for that stock. If a stock was purchased 5 years ago at a price of $30 and the current dividend is $3 per share. Accordingly, the yield on cost of this stock will be equal to 10%. The concept of "current dividend yield" should be distinguished from the yield on cost. The first refers to dividends divided by the current stock price, not the original purchase price.

Yield on Cost explained

Yield on cost demonstrates a dividend yield that is related to the original investment price. That is why stocks that have increased dividends can provide high annual interest rates, especially if they are held for a long time. Thus, long-term investors often hold stocks, current dividends on which are higher than the price originally paid for them, allowing them to receive a yield on cost of 100% or in some cases even higher.

Yield on cost calculation is based on the initial price paid for a stock. Therefore, investors should take into account and track the holding costs that they have incurred and can incur over the entire period of ownership of this security. The yield may seem unreasonably high if the cost component of the yield on cost calculation does not include all these costs.

Investors should be careful when evaluating dividend yields. If the yield on cost of a particular stock is greater than the current dividend yield of another company's stock, this does not mean that a security with a greater YOC is better than another one, because a company with a high yield on cost may have a low current dividend yield compared with other firms. In such cases, selling stocks with a high yield on cost and investing these funds in companies with a greater current dividend yield may be more profitable for the investor.

In addition, yield on cost analysis helps investors evaluate the long-term advantages of stocks over bonds. For example, bonds involve payments of fixed interest rates, but stocks have great long-term prospects because of growing dividends.

Yield on Cost example

For example, let's take a certain pensioner who is reviewing the investment returns from his pension. The current portfolio consists of a large position in X Corporation, acquired 10 years ago at a price of $15 per share. The current dividend yield of this company at the time of acquisition was 5% (1 dividend per share was $0.50). For the next 10 years, X increased its dividend by $0.50 a year. Planned to pay $4.5 per share this year. This stock price has risen to $50 per share, resulting in a yield on cost of 30% ($4.5 divided by the original purchase price of $15 per share) and a current dividend yield of 9% ($4.50 divided by current stock price of $50).

The retiree saw a high yield on cost annually and considered X to be the most successful investment, which is why he was really shocked to learn that his portfolio manager had sold the X position from his portfolio. In his most recent report, the action to acquire the assets of A company that has a similar to X financial strength, but with current yield of 10.00% was recorded. 

The portfolio manager explained to the retiree about his mistake. Instead of comparing yield on cost to the current dividend yield, the portfolio’s owner should have compared current dividend yields of these companies. Switching to A company was a fairly reasonable decision by the portfolio manager in terms of higher yield. However, if a pensioner plans to increase the yield on cost, the potential for dividend growth of companies is a more important criterion.