Last weekend I drove 4 hours to visit my family in St Louis, and rather than count blue cars, or listen to newscasters opine about the Chinese Spy Balloon, I decided my time was better spent listening to Kanwal Sarai’s Simply Investing Dividend Podcast.
If you hadn’t listened to Kanwal, I’ll go out on a limb and say I believe, he’d be worthy of your time. He’s a wealth of knowledge when it comes to Dividend Investing, and his straight-forward delivery is sure to entertain you.
Kanwal introduced me to a term, that before Saturday (the day I discovered his podcast) was something I wasn’t very familiar with. And if you’re fascinated by the power of Dividend Investing, like I am you’ll want to learn about the topic he taught me that day, which was; the importance of a stocks ‘Yield on Cost’.
To say it will amaze you, would be an understatement!
What is a Dividends Yield on Cost, and why does it matter.
In dividend investing, Yield on Cost is a fantastic way to illustrate the value ‘patience’ plays, with respect to long-term dividend holding.
Let’s break the term ‘Yield on Cost’ down to it’s least common denominator.
“Cost’ is the amount one paid to purchase the investment in question. Whether that investment is a stock, a bond, an ETF, real estate, or even a business, the cost is the amount used to secure the purchase.
The ‘Yield’ refers to the nominal value the ‘cost’ produces in terms of a return. You could even look at Yield on Cost in a broader business sense.
Say for instance; I’m a direct marketer who pays a 3rd party vendor to mail out thousands of marketing material every month.
Instead of using that vendor, I decide to buy a high resolution printer and an envelope folder, so I can print and mail those 1000’s of mail pieces myself.
Your cost is multi-dimensional:
You have the cost of the printer and envelope folder. You have the cost of raw materials (paper, ink, etc). You have the cost of an employees time, and their opportunity cost (could this employee be making you more money some other way). Then you have the cost of the maintenance of the printers and folders.
The Yield is; does this way of accomplishing the same goal (putting mail in the hands of consumers) save money, if so what is the percent of savings. Does it allow you to print more pieces of mail. Are there unforeseen benefits/consequences?
In reality, life is full of ‘Yields’ and ‘Costs’, and by taking a very granular look at most things in life, it will often provide a great deal of actionable evidence.
Since this post is about dividends though, lets look at how to calculate a dividends Yield on Cost:
Yield on Cost = Annual Dividend Income divided by Cost Basis.
The longer you hold that stock the larger your yield grows. In fact, it’s said that Warren Buffett’s Berkshire Hathaway’s yield on cost for its Coca Cola holding, is an astounding 54%.
And, if Berkshire Hathaway holds it’s Coca Cola stock long enough, its Yield on Cost will grow so large, that one day it’s annual dividend payment may surpass the amount they initially spent (cost) on its 1.2 Billion Shares.
The longer you hold your stock the more your yield grows. If I bought 50 shares of Microsoft today for $265 per share, my cost would be $13250. If I never bought another share of Microsoft that cost basis will always remain constant.
If, in the first quarter I was eligible for a dividend which paid me $.68 per share, I’d get a check for $34. Seems rather insignificant, I get it. But remember, this will happen 4 times per year, so I’d make $136 annually off of my investment of $13,250. Again, rather insignificant.
But, here is where the ‘Yield on Cost’ magic happens.
If you have a long time horizon and a whole lotta patience, you’d reinvest those dividend payments, then sit ideally watching your investment compound.
That same $13250 investment in Microsoft with reinvested dividends paints a whole different picture. It’s like the difference between a Paint by Number and a Van Gogh. Which one do you think is a better long term investment?
Let’s assume you did reinvest those $34 dividend payments for 5 years. And, lets assume for the sake of argument, Microsoft maintained that $.68 quarterly dividend payment for all 5 years and you received 20 payments. But, this time let’s imagine each payment went back into buying more shares.
Because you would be buying shares at different prices over that 5 year timeline, your reinvestments may look something like this:
At the end of 5 years, instead of having 50 shares you had 52.5859 shares. And, instead of getting a dividend payment of $34 each quarter, your payment would be $35.67.
So now, each payment was bigger because it was based on an increased share balance. Your Yield on Cost would grow from 1.03% in year 1 to 1.07% by year 5. Now imagine 5, 10, 15, 20 more years. At some point, if you hold your position long enough you too could have a 54% Yield on Cost, just like Buffett. And if so, he’d be ‘Omaha’ proud of you!
In the end, yield on cost is only one metric you can use to gauge an investments total return. It’s important to regularly analyze your investment’s return on cost, so you can avoid deploying ‘low yielding capital’. Low yielding capital is for sucka’s. Don’t be a sucka, Buffett wouldn’t approve.