The importance of Yield on Cost

Yield on cost  = annual dividend/purchase price

It may be a little ironic to talk about the importance of  yield on cost (YOC) in a blog called global dividend growth.

Should not the importance of YOC be a secondary consideration if long term dividend growth increases your income each year?

The answer is that YOC and dividend growth are both vital to long term performance.

How you start out has a large bearing on where you end up.  Let me explain with an example.

You buy two stocks on the same date:

Stock A has a YOC of 5%. Let us assume for the sake of illustration it has zero dividend growth indefinitely.

Stock B has a YOC of 3%, but increases the dividend  5% each year.

One would assume that the dividend grower would quickly catch up and surpass the zero growth stock.  Wrong.  It would actually take Stock B 11 years to match the payout of Stock A.  In addition, Stock A would have generated 25% more hard cold cash than Stock B in those 11 years.  If you add in modest growth of 2.5% for Stock A, that catch up period doubles to 22 years,  with Stock A generating 43% more cash.  I take on board that the above example is an over simplified theoretical example,  but you get the point.  Just 200 basis points of yield difference at the outset can have a huge impact on your long term results.  That is why you have to be patient and only buy when quality, dividend paying stocks are value priced.  I will post some of the parameters I use to determine when a security is value priced  in a future article.

Dividend growth in my opinion is the fundamental argument  for owning equity over debt.  More important than capital appreciation.  With bonds the coupon is fixed at issue.  Your income will not grow. That is why it is called Fixed Income.  But as important as growth in the dividend is, not overpaying to tap into that income stream is equally important to your long term success, as the above calculation illustrates.  That is the take away .

“It could be a great company but it may not necessarily be a good investment if your overpay for it at the outset.”  – Juliette John – Bissett  Dividend Income Fund

Advertisements

About globaldividendgrowth

Independent equity analyst focusing on global dividend growth opportunities.
This entry was posted in Uncategorized. Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s