The term "yield" is often misinterpreted by many investors. It strictly refers to the portion of dividend paid relative to the price of a stock. Many people looking to invest in dividends are satisfied with this definition and look for stocks that will provide them with the best possible return. This is a mistake because stocks are not fixed-income financial instruments. High yields are likely to decline, while the opposite is true for more modest distributions.
The yield changes daily depending on the stock price. Yield on Cost (YOC) is much more stable. It represents the ratio of dividends paid to what you paid for the stock. The cost is fixed and so is the ratio, as long as the dividend does not change. But if dividends increase over time, the YOC increases as well. Of course, if the dividend is reduced or eliminated, the YOC decreases.
In addition to being stable, the income from increasing returns can be very significant over the long term. The return on purchase cost thus shows you how much money your investment is making you, regardless of what happens in the market. In 2003, Chevron (CVX) was trading at 43.50 $ and paid an annual dividend of 1.43 $. This amount corresponds to a yield of 3.29%. Let's say you bought 100 shares at that time for a total investment of 4,350 $. CVX has increased its dividend every year since 2003 (in fact for 25 years), and it is now paying a dividend of 4.00 $ per share. If you have not purchased additional shares in the last 10 years, the total cost is still the same, 4,350 $, or 43.50 $ / share. Therefore, the yield relative to the purchase cost today is $ 4.00 / $ 43.50 = 9.2%! In other words, CVX today offers 3.3% in dividends, but the shares purchased in 2003 offer 9.2%!
Good companies tend to have low payout ratios. The money used in dividends is only a small percentage of their income. It will take some time for the yield on purchase cost to be competitive with high yield stocks, but the stability of dividends and their potential for appreciation more than compensate for this small handicap.
The next time you want to buy a high-yielding stock, think about this:
- Can the company afford to pay a dividend regularly?
- Has the company ever lowered its dividends in the past?
- Have dividends remained unchanged for many years?
- Does the overly generous payout ratio compromise future growth?
- Is the payout ratio likely to lead to a dividend cut or reduction?
I told you in the introduction that it does not move as long as the dividends do not change. This is true if we stay in the same currency. Of course, if we receive distributions in another currency, such as the dollar, this can have a certain impact on the YOC. For this reason, it is important to select titles that react favorably to a fall in the greenback. American companies that are highly exporting, for example, benefit from a weak dollar, which allows them to increase their sales or margins, therefore their profits, therefore their dividends and their share price. A drop in the value of a dividend in CHF caused by a weakening of the greenback against the Swiss franc can therefore be offset by an increase in the dividend in USD.
As of this writing, I have 24 titles in my wallet. Currently, the YOC of my portfolio stands at 2.88%. It has slightly decreased, not so much because of the recent decline in the USD/CHF but because of three purchases made in 2013. In fact, I calculate my yield on purchase cost by dividing the value of the dividends received during the last twelve months by the purchase value of the securities making up the portfolio. Thus, these last three purchases increase the value of the capital purchased even though they have only distributed a very small part of their dividends. Without this, I would be at a YOC of more than 3% today.
Using my projection model, here are the returns I expect in the coming years:
- Today 3%
- 3 years 4%
- 5 years 4.8%
- 10 years 7.7%
- 20 years 20%
20% in 20 years... enough to comfortably secure my retirement. But I intend to take it before then! And you?
Sources:
http://myfijourney.com/2013/03/01/the-difference-between-yield-and-yield-on-cost/
http://wealthartisan.com/yield-on-cost/
http://www.stockodo.com/dividend-yield-vs-yield-on-cost/
http://www.easysafemoney.com/yield-on-cost/
http://dividendsvalue.com/1122/yield-on-cost-measuring-for-success/
Discover more from dividendes
Subscribe to get the latest posts sent to your email.
Français 
English 
Italiano 
Deutsch 
Español 
Português
Hello Jerome,
I am taking advantage of your last article to come back a little to the principles of the timing of purchases on securities with growing dividends, it is not every day that one can "take advantage" of a mortgage crisis such as that of 2008 to position oneself on grower dividends,,,
So, I will take as an example a title on which the leader of the site becoming a rentier has recently positioned itself (it also publishes a detailed study): DLR (digital realty trust) if I look at the divs over 10 years they are increasing http://www.dividendladder.com/tools/dividend-history/
and if I look at the graph, significant correction of around 37 % since the beginning of 2013, the beta is low, the payout ratio on the other hand higher than 100% but it is apparently due to a regulatory specificity of REITs
What are the arguments for taking a position from your point of view?
I don't know this stock but I can see the appeal. Earnings and dividends are steadily rising, while the price is trending in the opposite direction. It almost seems too good to be true...? Where is it going wrong?
The payout of 143% is indeed due to the accounting specificities of the real estate sector. I would say that a priori it is only the fact that they operate in the technological real estate sector that bothers me, because it is potentially highly exposed to economic fluctuations. But this is not what explains the drop in the price ... and there are always very good reasons for a price to fall in this way.
These are details that frame the future of any investor. So, it is better to be aware when choosing the path to follow so as not to end up with an irreparable loss.
Is this a charade or a rebus??? 😉
@guyem
My comment is not clear???
Not really for me in fact, it's the words details (which ones??) and path that seem to me to need to be clarified,,,
Thanks in advance
I am particularly interested in this article because I would like to create my own return to be able to realize my dream: to become a winegrower! But from what I see it is far from being won for me, with all the conditions to respect: dividends, distribution ratio...
By details I mean the return calculated in relation to the price of a stock as well as the return calculated in relation to the purchase cost. The path is the one an investor chooses to define his own return.
I take this opportunity to wish you a happy new year 2014.
OK, I understand better this way, on this subject I have only spotted stock rover which allows to compare fairly quickly the stock market quotation and the company value,,,,, if some have better means,,,,
Best wishes to all in the meantime ,,,, 😉
Enterprise value doesn't tell you anything. What matters is momentum and price action. A moving average will tell you more. And it's much simpler. Although it takes a bit of experience, of course.
Hello Jerome,
Thank you for this useful information,
I have a quick question about your projection model. Your YOC yield increases year after year until it reaches 20% in 20 years. Are you planning to get that from just the investments you have already made, or by including future investments? If it is a projection that includes your future investments, then how can you increase your yield since every time you reinvest your YOC decreases?
Lionel
Hi Lionel. In the example here it is only on the basis of the current portfolio, without future purchases. Obviously, subsequent acquisitions lower the YOC, but at the same time they increase the annuity in absolute value. Thanks to savings but also to the reinvestment of dividends received, one can thus very significantly accelerate one's progress towards financial independence. It should also be noted that the negative impact of each purchase on the YOC diminishes as the portfolio grows and that in certain circumstances it can even be positive (purchase of a security whose yield is higher than the YOC of the portfolio).
Absolutely, many recommend buying stocks with a high "dividend". But it is better to buy growth stocks that pay low dividends, which, in absolute value, are increasing.