Yield on Cost is an important concept to understand as a dividend growth investor. Yield on Cost is the future yield an investment is producing based on the yield that was received at the time of purchase, plus the growth of the dividend over time. Since the cost basis remains constant, when a company increases the dividend, the yield on your original investment goes up.
If a company pays a 3% dividend when purchasing the stock and then raises the dividend 7% that year, the new yield, based on the price paid, would be .03 x 1.07 = 3.21%.
This may not seem to be a lot in one year, but consider that the investor may be holding onto this investment for 10, 20 or even more years. If the company can continue to increase the dividend each year at a similar rate, the future yield, and the income that comes along with that, will be much higher since the investor paid a lower amount and the dividend has grown.
Alternatively, if the investor did not invest in this company and waited 10 years, that new investment would pay the yield at that time, which for quality dividend growth stocks remains pretty constant over time, instead of the higher yield on cost that someone who bought the stock and held it for those 10 years would receive.
For that new investor, even though the company continued to increase the dividend, the price that the company trades at also went up over that time, so the yield would remain similar to the past yields.
I have included some case examples of very popular dividend growth companies. You can see from the chart that an investor should look at both the current starting yield plus look at the potential dividend growth. A low current dividend, accompanied by a high dividend growth rate, can surpass a high current dividend yield with low dividend growth in just a matter of a few years.
Note that the dividend growth rates below are based on the past 5 year average increases and there is no guarantee that the growth would continue, but it will give a sense on the importance of looking at yield and growth when choosing to invest in a company.
Depending on the investor’s timeline, the tradeoff between current and future yield will be different, so the investor will have to understand their needs and timeline.
