Investing in dividend paying stocks is a popular investment method for successful income investors. One of the first things you will need to know is how to calculate the yield on cost, an important financial ratio used to help select investments. While the current dividend yield of a stock is readily accessible on any financial website, the yield on cost (YOC) is specific to your individual investments.
The dividend yield is calculated by taking the annual dividend of the stock and dividing it by the current share price. While this ratio can be an important metric, there are some flaws. First, it is a constantly changing number which makes it difficult to track. As the share price fluctuates, so does the current yield.
Another drawback of the dividend yield is that since it follows the current share price of the stock, it doesn’t really help an investor who already owns shares. This is where the YOC can come in useful for an investor, as it tracks the yield of the stock in relation to what you paid to own it.
Since the yield on cost represents each investor differently, it won’t be found on any financial website. Therefore, it is important for a dividend investor to understand how to calculate this financial ratio so it can be used to make critical investment decisions.
Yield on Cost Calculation
Calculating the yield on cost is a simple equation that takes two pieces of information. First, you need to know what the annual dividend currently is set at for the stock you are running the calculation on. If you don’t know what this is, check with your online broker or on one of the financial websites.
The second number that you will need is your average cost per share of the stock. You may need to do some figuring on your average share price, but your broker should be able to provide this data. Once you have collected both pieces of data, the following equation can be used to run the calculation.
Yield on Cost = (Annual Dividend / Average Cost per Share) * 100
As you can tell, the yield on cost equation is very simple and easy to calculate. It provides important information that is tied directly to the current yield that you are earning from owning the stock, not what the current yield states.
Example Yield on Cost Scenario
Let’s say that an investor purchased 20 shares of a dividend paying stock at $30 per share. A few weeks later, the investor decided to take advantage of a drop in the share price to dollar cost average down and purchased 20 additional shares at $26 per share.
The end result is that the investor now owns 40 shares of the stock at an average purchase price of $28.
If the company has an annual dividend of $1.00 per share, then the yield on cost for the investor would be equal to 3.57% based on the calculation below.
YOC = ($1.00 / $28.00 ) * 100
If the stock is currently trading at $30 per share, then the current yield would be equal to 3.33%, which is lower than the YOC. As the company raises or lowers dividends overtime, the yield on cost for an investor will fluctuate and provide the investor a true return on their investment.
Similar to the current dividend yield, the yield on cost of a stock provides helpful information to a income investor. Unlike the current yield of a company, the YOC is different for every investor who already own shares of the stock. This financial calculation can be very helpful as it gives the investor a true return on investment as opposed to the yield on the current share price of a stock.