Dividend Yield on Cost Is Irrelevant

By: ispeculatornew
Date posted: 05.22.2013 (3:00 am) | Write a Comment  (6 Comments)

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yieldThere are some expressions used that I just don’t get. Maybe it’s me that’s way off, or maybe those that mention it don’t know what they’re talking about. Today, I mentioned one of those in a newsletter that I sent out and wanted to get your thoughts on another one. I’ve seen this one mentioned several times on blogs, but even in discussions with friends. Before giving you my opinion, in case you don’t know, dividend yield on cost is generally described as:

-the annual dividend paid out by a company / average cost of that position

In some cases, it could be perceived as useful by some dividend-focused investors. If you buy a stock for $50 that pays a $1.50 dividend (3% yield) and that over 5-10 years that dividend increases to $3/year, some would say that the yield on cost is now 6%. In a way, it does represent the fact that the investment probably did very well. The stock increased its dividend by 100% and its price also likely increase significantly. If the yield remains at 3%, the stock would now be worth 100% more.

So yes, I could see how the average cost would be “useful” in such a context.

But tools to analyze stocks should work most if not all of the time. There are countless examples where this does not work as well. Take that same stock described earlier and imagine that the company is struggling. Yes it did increase the dividend over the years but it is also paying out more than what it is making (payout ratio > 100%). In such a scenario, the stock price would have decreased significantly.

So yes, both stocks would have a 6% dividend yield on cost… but they can’t be compared.

Average Cost Is (Mostly) Irrelevant

There is one big reason why I look at my average cost; taxes. When trading in a taxable account, average cost does make a difference in trying to determine if a position should be closed, especially near year-end.

But otherwise? Not in a million years. If I purchased a dividend stock 10 years ago in a taxable account and it pays out a 3% dividend yield, I would evaluate it in the same way as any other stock no matter if I’m up 10% or down 50% on the stock, it’s irrelevant. Yes, from a psychology standpoint, it’s difficult to sell a stock and make a loss “official”, we always hope the trade will revert. But in most cases, it’s a big mistake to hold on to a stock for those reasons.

Do you believe in using yield on cost or average cost in general? If so, how do you use it?

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6 Comments

  1. Comment by Juice — May 22, 2013 @ 4:17 am

    If an investor had multiple purchases of the stock, it is a useful back-of-the-envelope calculation to monitor if the investment’s dividends payout is increasing over time.

    It should not be the only calculation someone looks at when they are monitoring their portfolio, just like someone would not look at solely the dividend payout ratio.

    I think you may be getting confused because you seem to want to use the total return of a stock whereas the yield-on-cost is used to evaluate only the income portion of the investment.

    I think the issue you may be having is that you want to include the capital gains as part of the calculations. This

  2. Comment by Evan — May 22, 2013 @ 6:50 am

    If you buy 100 share of Facebook at $30 and the price declines to $26, you have an average cost of $30. It looks bad, I agree.

    If you buy 100 more shares at $26, then your new average price is $28 (bought half at $26 and half at $30)… so yes, it looks better on paper. But it’s the exact same loss!!

    ****

    No it is not the same. In the second scenario you have 200 shares vs 100 shares. It isn’t the same lost because 200 shares at 30 to 26 equals $800 loss vs 200 shares (100 at 30 and 100 at 28) equals a loss of $600.

  3. Comment by IS — May 22, 2013 @ 6:51 am

    @Evan, Yes, because you purchased more.. but I mean it’s the same loss for that initial 100 shares that you bought, maybe I didn’t explain it correctly but thanks for clarifying:)

  4. Comment by The Dividend Engineer — May 24, 2013 @ 7:05 am

    As any metric, YOC should not be used alone.

    It’s a good metric to measure how your dividends are growing with respect to the purchase price of a stock but it’s not a good metric to measure total return.

    Like P/E, dividend yield, payout ratio and countless other metrics, YOC should be put in context. A low P/E could mean a great bargain or a falling knife. Same thing for a high dividend yield.

    In fact, no single metric should be the sole deciding factor in buying, selling or keeping a stock.

  5. Comment by IntelligentSpeculator — May 24, 2013 @ 7:38 am

    @The Dividend Engineer – Yes, if you use it that way, I do agree. And I agree 100% that no single metric would ever be enough.. !

  6. […] @ Intelligent Speculator writes Dividend Yield on Cost Is Irrelevant – Why we don’t care for the dividend yield on […]

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