What Is Yield on Cost (YOC)?
Yield on cost (YOC) is a measure of dividend yield calculated by dividing a stock's current dividend by the price initially paid for that stock. For example, if an investor purchased a stock five years ago for $20, and its current dividend is $1.50 per share, then the YOC for that stock would be 7.5%.
YOC should not be confused with the term "current dividend yield." The latter refers to the dividend payment divided by the stock's current price, rather than the price at which it was initially purchased.
- YOC is a measure of dividend yield based on the original price paid for the investment.
- YOC can grow significantly over time if the company regularly increases its dividend, so investing for dividend growth is the way for long-term investors to maximize YOC.
- Investors using YOC should ensure they do not compare it to other stocks' current dividend yields, as this is an apples-to-oranges comparison.
Understanding Yield on Cost (YOC)
YOC shows the dividend yield associated with the initial price paid for an investment. For that reason, stocks that have grown their dividends over time can deliver very high YOCs, especially if the investor has held on to the stock for many years. In fact, it is not unusual for long-term investors to own stocks whose current dividend payments are higher than the original price paid for the security, producing a YOC of 100% or greater.
YOC is calculated based on the initial price paid for a security. Therefore, investors must make sure they keep track of the holding costs they have incurred for that security over time, as well as any additional share purchases they have made. All of these costs should be included in the cost component of the YOC calculation. Otherwise, the yield will appear unrealistically high.
When evaluating dividend yields, investors must also be careful not to compare apples and oranges. Specifically, just because a stock's YOC is higher than the current dividend yield of another company, it does not mean that the stock with the higher YOC is necessarily the better investment. That is because the company with the high YOC may actually have a lower current dividend yield than other companies.
In these situations, the investor could be better off selling their shares in the high YOC company and investing the proceeds in a company with a higher current dividend yield.
Considering (YOC) shows investors the long-term benefits of stocks compared to bonds. Since bonds pay fixed interest rates rather than dividends that grow, they have much less long-term potential.
Example of Yield on Cost (YOC)
Emma is a retiree who is reviewing her pension's investment returns. Her portfolio includes a large position in XYZ Corporation, which her portfolio manager purchased 15 years ago for $10/share. When it was purchased, XYZ had a current dividend yield of 5% based on a dividend of $0.50 per share.
In each of the 15 years that followed, XYZ raised its dividend by $0.20 per year. It is expected to pay $3.50 per share this year. Its stock price has risen to $50 per share, resulting in a YOC of 35% ($3.50 divided by the initial $10/share purchase price) and a current dividend yield of 7% ($3.50 divided by the current $50 share price).
Emma considers XYZ to have been one of her most successful investments. She takes satisfaction out of seeing the lofty YOC that it produces every year. Looking over the most recent report from her portfolio manager, she was therefore shocked to find that they had sold the XYZ position. The manager reinvested the proceeds in ABC Industries, a company with similar financial strength as XYZ, but with a current yield of 8.50%. Dismayed by this seemingly foolish decision, Emma calls her portfolio manager. She asks why they sold a position yielding 35% in exchange for one yielding only 8.50%.
The portfolio manager explains to Emma that she has made a common mistake. Rather than comparing YOC to the current dividend yield, she should make an apples-to-apples comparison between both companies' current dividend yields. From this perspective, switching to ABC was perhaps a wise choice because it offered a higher yield on her money—8.50% versus 7%. However, the two companies' dividend growth prospects are more important if Emma wants to continue increasing the yield on cost.