Published on October 9th, 2018 by Bob Ciura
Dividend investors are likely familiar with the concept of current yield. It is a fairly easy statistic to find—a number of financial websites will show the current dividend yield of the stock, and it is just as easy for investors to calculate it themselves.
Yield on cost is similar to current yield, but there are also significant differences between the two. While the current dividend yield is simply the company’s dividend per share divided by the current share price, yield on cost is the current dividend per share divided by the investor’s cost basis.
Yield on cost is the yield of the stock from a historical basis, considering the original price paid and not the current price.
Each investor’s yield on cost might be different, as it depends on the purchase price of the stock, as well as how many dividends were reinvested during the stock holding period. Current yield is a very important statistic for investors to keep in mind, but so is yield on cost.
How To Calculate Yield On Cost
To calculate yield on cost, divide the current dividend per share by the cost basis per share. Then, multiply by 100 to derive a percentage. The current dividend yield of the stock will tell an investor how much income they will receive each year, as a percentage, if he or she buys the stock today. It is the current dividend divided by the current share price. For example, a stock with a current dividend payment of $2.00 per share with a $50 share price will have a current yield of 4.0%.
Meanwhile, the yield on cost could be different if an investor purchased shares at a lower price. For example, if an investor purchased the same stock referenced above one year ago for $40, the yield on cost would be 5.0%. Yield on cost compares the current dividend with the investor’s cost basis. Cost basis is determined by the original purchase price. The cost basis could be different than the current share price, if the investor purchased the stock years ago at a lower price.
Furthermore, yield on cost could be even lower for investors who purchased shares years ago, if they reinvested those dividend payments back into the stock. Another way yield on cost can rise over time is by selecting stocks that raise their dividends over time. Dividend growth stocks reward their shareholders who buy and hold for the long-term with higher dividend income each year.
For example, an investor could buy shares of a stock trading for $100 per share, with a current dividend of $1.00 per share. This stock would have a current yield of 1.0%. If the company has strong fundamentals and grows its revenue and earnings over time, they may decide to raise their dividend payment to shareholders. Assuming the company raises its dividend by 10% per year, in five years it would pay a dividend of $1.61 per share. By contrast, stocks that do not raise their dividends will pay the same dividend every year.
Reinvesting dividends will also grow an investor’s yield on cost, even if the share price does not change over the holding period.
Assuming the investor purchased 100 shares of stock one year ago at $40 per share, for a total investment of $4,000. Further assume that the investor received dividends of $2.00 per share. The investor would have earned $200 in dividend income over the course of the year. Even if the stock price stayed at $40 after one year, this investor would have a higher yield on cost if they reinvested those dividends to buy more shares of stock.
Reinvesting the $200 would have purchased an additional five shares of stock, at a price of $40 per share. This means the investor would now have 105 shares of stock after one year of reinvested dividends. With an original investment of $4,000 the investor’s cost basis would now be $38.09, instead of $40. The current dividend of $2.00 results in a yield on cost of 5.25%, instead of 5.0% had the investor not reinvested dividends.
Yield On Cost Excel Calculator
The free downloadable Excel Sheet below provides a simple yield on cost calculator. Use the link below to download the spreadsheet. How-to-use instructions are included in the spreadsheet.
Yield On Cost vs. Current Yield
Reinvesting dividends helps grow yield on cost over time, and it demonstrates the power of compounding interest. Using dividends to buy more shares of stock will provide investors with more shares of the company. In turn, this results in more dividends, which can be used to buy more shares, and so on.
Yield on cost is a backward-looking metric. An investor might have a very high yield on cost, which indicates they are generating a high level of income compared with their cost basis. But it does not by itself tell an investor whether the stock is a good investment today. In cases where an investor has a high yield on cost but the current dividend yield is very low, the investor is likely sitting on a large unrealized gain.
If the current yield of the stock is very low, it could be the result of a rapid increase in the share price since the investor first purchased shares. In some cases, this could actually be an opportunity to harvest those gains, and reinvest the proceeds in a different stock with a higher current yield. This would have the impact of generating more dividend income.
Assume an investor has a yield on cost of 5.0% on a stock that now has a current yield of 1.0%. If the investor is sitting on a large unrealized gain, the investor could sell the stock and reinvest in a high-yielding stock. If the investor sold shares of the 1% yielding stock and bought shares of a stock yielding 3% or 4%, for example, the investor would significantly increase their overall portfolio income. Of course, investors should understand the potential capital gains tax from selling a stock.
There is an abundance of key metrics and ratios that investors should know before buying individual stocks. When it comes to dividend stocks, investors should understand the difference between current yield and yield on cost. Both are important statistics that play a role in how an investor builds a portfolio of high-quality dividend stocks.