Yield on Cost: How to Calculate and Apply It

Yield on Cost: How to Calculate and Apply It

Yield on cost is a common metric cited by dividend investors as they measure and manage their portfolios.

 

But is yield on cost really one of the most important financial ratios for successful dividend investing?

 

In this article, I will provide my definition of what yield on cost is, show how to calculate it, and analyze the pros and cons of using the metric to improve investment results.

 

What is Yield on Cost?

Simply put, yield on cost measures the rate of dividend income your original investment earns today. Put another way, yield on cost is essentially the dividend yield based on your initial investment in a stock.

 

If a company increases its dividend after you purchased shares, you will enjoy a higher rate of income return on your original investment – your yield on cost rises.

 

Dividend investors like tracking the yield on cost of their holdings to see the power of consistent dividend growth. It is exciting to see an investment literally begin to pay for itself with higher dividend income over time.

 

Let’s take a closer look at how yield on cost is calculated.

 

How to Calculate Yield on Cost

Calculating yield on cost is similar to calculating a stock’s dividend yield. The first step is to find a company’s annual dividend payout per share.

 

This information can be quickly retrieved for a company in the Dividend Information section of our Stock Analyzer tool (look under the “Annual Payout” label).

 

A company’s annual dividend then needs to be divided by the investor’s cost basis per share. An investor’s cost basis represents the price he paid to acquire his shares.

 

Let’s try an example. Suppose I bought 50 shares of Colgate at $55 per share. The stock currently trades at $70 and pays annual dividends of $1.56 per share.

 

The company’s dividend yield would be 2.2% ($1.56 per share in dividends / $70 current stock price).

 

However, my yield on cost would be 2.8% ($1.56 per share in dividends / $55 cost basis per share).

 

If Colgate raised its dividend by 8% to $1.68 per share, my yield on cost would rise to 3.1% ($1.68 per share in dividends / $55 cost basis per share).

 

Yield on cost increases when a company raises its dividend and decreases when a company cuts its dividend.

 

Cost basis information can become complicated as investors make additional purchases of existing holdings through direct purchases or dividend reinvestment plans.

 

Fortunately, brokers can supply investors with their cost basis information for each of their holdings.

 

Tracking Your Portfolio’s Yield on Cost

With dividend information constantly changing, tracking a portfolio’s yield on cost data can be a challenging task.

 

I track my portfolios’ yield on cost information using our Portfolio Analyzer tool. As seen below, the tool shows each holding’s yield on cost and dividend yield (two of the last three columns on the right).

 

 

The Portfolio Analyzer also shows my portfolio’s overall yield on cost. As seen below, one of my portfolios has a dividend yield of 3.05% but a yield on cost of 3.57%.

 

 

While tracking yield on cost data is fairly straightforward, let’s take a closer look at how dividend investors should apply the metric.

 

The Benefits of Yield on Cost

Yield on cost highlights the power of a dividend growth strategy and can be useful for retirement planning.

 

For example, suppose we invested $100,000 in Colgate today and purchased shares at a price of $73 per share. The company currently pays dividends of $1.56 per year, resulting in an initial yield on cost of 2.14% and annual dividend income of approximately $2,137.

 

If Colgate grew its dividend by 8% per year from 2017 through 2025, the yield on cost of our investment would double from 2.14% to 4.27%.

 

Instead of generating $2,137 of dividend income per year, our original investment of $100,000 would now be throwing off about $4,272 of annual dividend income. If dividends were being reinvested over this time, our future income would be even higher.

 

This is a key advantage that dividend growth investing has over purchasing bonds with fixed interest rates. While stocks are much more volatile investments, a bond paying 2% today will still be paying 2% in the future – regardless of inflation.

 

Blue-chip dividend stocks provide an opportunity to earn higher income on our original investment over time, but it doesn’t happen overnight.

 

 

A rising yield on cost results from a company growing its dividend. In addition to providing higher income in the future, companies that consistently increase their dividends tend to have strong performance track records.

 

For example, the S&P Dividend Aristocrats Index has outperformed the market by about 3% over the last decade.

 

In addition to the benefits of higher dividend income over time, a portfolio that sees its yield on cost rise is likely appreciating in value as well (rising dividends are often the sign of a healthy, growing business).

 

Using the Colgate example above, if the company’s dividend rose from $1.56 per share in 2016 to $3.12 in 2025, its stock price would almost certainly have appreciated.

 

If Colgate had a dividend yield of 2.5% in 2025, its share price would be approximately $125, representing an increase of more than 70% since our purchase in 2016.

 

A rising portfolio value provides investors with more flexibility down the road because they could decide to sell their current holdings and reinvest in stocks that offer higher yields, resulting in even greater current income when they need it.

 

The Cons of Yield on Cost

Despite the excitement created by a rising yield on cost, investors must remain aware that yield on cost is mostly a backwards-looking measure.

 

Yield on cost tells us little about a company’s future growth potential and underlying business fundamentals. Yield on cost simply informs an investor whether a stock’s dividend has been rising or falling since the investment was purchased, and we shouldn’t necessarily extrapolate the past.

 

Perhaps more importantly, we need to guard ourselves from falling in love with a holding simply because it has a high yield on cost.

 

Investors should resist the emotional temptation to hold a stock with a high yield on cost if the investment is no longer attractive.

 

There is always an opportunity cost to consider from holding a stock, and it’s important to remember that dividend income is only part of the total return equation.

 

Personally, yield on cost does not play a role in my investment decisions or process to build a dividend portfolio. I try to focus on actionable metrics that can provide clues about a company’s future.

 

My goal is to own businesses that can consistently grow their earnings over the long term to provide me with rising dividend income and a more valuable portfolio over time.

 

By studying how an industry works, reviewing a company’s track record, and analyzing a number of financial ratios, I can make progress on my goal.

 

Yield on cost doesn’t really help me accomplish any of these things, but it should steadily rise over time if my efforts are successful.

 

In other words, I view yield on cost as an output of my investment process – not an input.

 

Closing Thoughts

Yield on cost is one of the most popular metrics used by dividend investors. While a rising yield on cost can signal a winning dividend growth strategy, the measure itself is not all that useful when it comes to making incremental investment decisions.

 

Instead, we need to evaluate the fundamentals of a business and make sure its dividend safety and growth profile are still aligned with our investment objectives. As the great hockey legend Wayne Gretzky once said, “I skate to where the puck is going to be, not where it has been.”