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Dividend Yield on Cost Is Irrelevant

May 22, 2013
There 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?


Rating: 3.6/5 (5 votes)

Comments

cdubey
Cdubey premium member - 10 months ago
This (your arguments) could as well be generalized to argue that what you pay for a stock is irrelevant *after* you have completed the purchase.

I don't see the relation to dividend. Nevertheless, the overall emphasis on "value" instead of "cost" is something we all should strive for.
idleangelhk
Idleangelhk - 10 months ago
I don't really understand what you are saying... but i'm guessing

1. about a tax problem

2. the stock is a loss if you sell

3. the stock dividend is up and payout ratio over 100%

4. averaging down on a stock

5. the company is failing

And your saying its wrong to hold a stock for these reasons?
hasagos
Hasagos premium member - 10 months ago
I think you have a few misperceptions on yield on cost.

Firstly, a rational yield-on-cost investor is going to select companies that have the specific attribute of being able to generate more and more earnings and cashflow over the course of time. This attribute is not so common amongst the broader array of stocks out there. But, since the yield-on-cost investor is specifically targeting this specific attribute, the probability of the payout ratio going above 100% is not likely. And if it were, I suspect the warning signs would likely appear well in advanced.

Secondly, the yield-on-cost investor is focused on INTERNAL measurements, rather than external, as the gauge of the investment performance. If the internal performance of the company is good, over the course of time the external will take care of itself.

Thirdly, there are significant tax consequences to continuous buying and selling. So, I think a rational yield-on-cost investor would only sell his holdings if the market were to offer a bubble-like valuation. Otherwise, it’s probably not worth the effort of compounding workload in order to chase a greatly diminished rate of return. Particularly when the universe of companies who meet the specific attribute standards are quite limited.

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