Calculating Yield on Cost

How to Earn a Strong Yield on Cost (YOC)

Strategy

I’ve described yield on cost as the life-blood of the dividend growth investor. A dividend growth investor seeks out companies which have a history of raising their dividend yields every year without fail. Consistency in raising dividends is extremely important for a dividend growth investor as we count on increasing dividends to combat inflation through out the years and bulk up our dividend income, which will eventually be used to live off.

What is Yield on Cost?

According to Investopedia,

Yield on cost is an investment‘s annual dividend divided by the original purchase price of the investment.

A simple enough description. The yield on cost for every dividend growth investment is expected to grow, hence the name, dividend growth investing. If you follow my stock analyses, you’ll notice that yield on cost has it’s own separate section because it is a very important factor for me to look at before I make an investment. In fact, according to The Dividend Beginner stock picking strategy, a stock must have a 10-year YOC of at least 6% to pass my selection criteria.

WHY: The whole point of dividend growth is so that later in life you can reap rewards from the seeds you planted TODAY. If I’m not getting a yield of at least 6% in 10 years from now, then I’m not generating a ton of future cash flow in relation to my investments today.

How to Earn a Strong Yield on Cost

You can scoop up companies with a strong YOC in two different ways.

  1. Buying shares in companies who’ve had their stock price reduced by a large percentage usually have a large yield due to the share price reduction. This will allow you to have a larger starting yield, which, combined with dividend growth – will earn you a strong YOC.
  2. Buying shares in companies who have a high dividend growth rate (I like companies with double-digit dividend growth); despite their current yield, with a high dividend growth then the yield will increase as time goes by and earn you a strong YOC.

My most recent analysis of National Bank of Canada (NA) depicts how NA’s high starting yield and mid-to-high dividend growth rate work together to earn investors a strong YOC. Let’s check out exactly how this works out as an exercise for dividend beginners. First let’s lay out all the metrics which are important in observing an expected yield on cost.

Calculating Yield on Cost

National Bank of Canada
Stock Price $36.79
Annual Dividend $2.16
Dividend Yield (starting yield) 5.87%
5-Year Dividend Growth Rate 10.03%
10-Year Dividend Growth Rate 8.86%

*Numbers are from Feb 15, 2016.

The dividend yield is easily calculable by dividing the annual dividend by the current stock price.

Dividend yield = $2.16 / $36.79  = 0.0587 * 100 = 5.87% 

The dividend yield of 5.87% will be our starting yield, since that is how much percentage we would receive in dividends from our investment on an annual basis. So, what we want to know through an expected yield on cost is: how much will our investment be paying us in 10 years based on the money we’re investing today?

To figure this out, we can use either the 5- or 10-year dividend growth rates in our calculations for an expected yield on cost. Sometimes it’s more prudent and cautious to lower these growth rates depending on the company’s well-being and the state of the economy. For simplicity’s sake, let’s figure out what our expected 10-year yield on cost would be using both the 5-year and 10-year growth rates for comparison.

We can calculate expected yield on cost like this

Yield on Cost = ((1 + Dividend Growth Rate / 100)Years of compounding) * Dividend Yield

So given this equation, let’s calculate the expected 10-year yield on cost based first on the 5-year dividend growth rate of 10.03% and then based on the 10-year dividend growth rate of 8.86%. Considering 8.86% is smaller, and spans a wider range of years, it is a more conservative estimate.

Using the 10-year dividend growth rate

dividend growth rate = 8.86%

years of compounding = 10

dividend yield = 5.87%

Yield on cost = ((1.0886)10) * 5.87 = 13.72%

Using the 5-year dividend growth rate

dividend growth rate = 10.03%

Yield on cost = ((1.1003)10)*5.87 = 15.27%

Remember, Remain Cautious and Conservative

Provided, with the state of the Canadian economy and the potential oil and housing risks attributed to the Canadian banks, it’s possible the dividend growth rate may slow down or even be suspended, as nothing is guaranteed when it comes to dividends – however we’re making an educated guess when we calculate expected yield on costs.

This is one reason I really adore companies which have dividend growth programs / plans or expectations, some such companies are Telus (T) and Transcanada Corp. (TRP); with this information it’s easier to calculate an expected yield on cost. However, one must be aware of companies which will announce their expectations to raise dividends and then cut them out of the blue, as Kinder Morgan did – angering many investors.

What do my fellow investors think about yields, dividend growth rates, and yield on costs? What combination do you strive for when choosing your investments?

I’ll be adding an “Expected Yield on Cost” calculator sometime in the future to this site, as I could not find a good one that fit this strategy well. Be sure to subscribe to The Dividend Beginner newsletter to have the release sent to your e-mail inbox.

Dividend Beginner

A 22 year old Canadian dividend growth investor striving for early financial independence; building as many passive income streams as early as possible.
Previous
Dividend Stock Analysis: National Bank of Canada (NA)
Next
Weekly Market Review (Feb 15 – 19)
  • Yield on cost is a great way to evaluate dividend growth investments, over time. I find it very encouraging to look back at some of the investments I made during the 2009 financial crisis, and see that I am now earning 8-10% in annual dividend income off those investments. I’m sure I could be earning even more from high yield investments, but many of those are outside my circle of competency. Furthermore, in a decade or two…..those investments many well be paying 20% (yoc) annually.

    Time is the friend of the patient investor, and the strong business.
    -Bryan

    • Hey IS,

      Yield on cost is by far my favourite metric to look at when evaluating investments. You’ve got a very strong yield on cost in the past seven years then, that’s great! Looking forward to seeing you get up to 20%, would be great news.

      DB

  • I do understand the conept an value of yield on cost.
    Do you also use yield on actual price? It looks useful to me as well. Imagine you have a stock that now yields 3pct. What if you can buy on that yields 3,2pct? Would you switch only based on that? Or do you also look at the historical yield growth and other pamaters?

    • HI Amber,

      Your comment is a little confusing so I can’t address everything you seem to be asking. If a stock is yielding 3.2% rather than 3%, that has very little sway in my decision-making process. I do look at historical dividend growth rates, which is why I’ve included calculations using the 5- and 10-year dividend growth rates here, as well as payout ratios, and other metrics you can see in my stock picking strategy.

      Thanks for commenting,
      DB

  • A very good article DB and a great way to show the power of patience of reaping in the benefits of growing dividends.

    It’s important that the earnings are also growing with the dividends if not growing more, otherwise the payout ratio will become steadily more unaffordable and less re-invested profits each year back into the business.

    Warren Buffet has a heck of a YOC.

    • Hey Tristan,

      I appreciate your compliment. Expected YOC definitely exemplifies the power of growing dividends.

      You bring up a good point there; another thing to be cautious of when examining future expected YOC, which will likely have you readjust your expected dividend growth rates in line with earnings growth.

      Thanks for commenting,
      DB

  • A very good article. A clear mathod to calculate your future earnings.
    I also calculate YOC this way and use it, among other metrics, in my decisions
    Keep up the good work!

    Cheers,

    Pollie

  • This is where the gold is. The ultimate form of compounding interest is an increasing YOC, because you are essentially getting double compound interest if you are also doing DRIP.

    Wanted to contact you but didn’t see a “contact me” page. I’ve left my email through your comment form.

Leave a comment

Your email address will not be published.

Archives




Finance Blogs

Disclaimer

My publishings on dividendbeginner.com references an opinion and is for information or entertainment purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. I am not responsible for any decisions you make concerning finances, taxes, or investments. You must perform your own research and always take caution when extending capital.