Yield on cost explained

How is yield on cost calculated?

Yield on cost = current annual dividend per share ÷ original purchase price per share

Suppose you bought shares of a hypothetical company at $40 when it paid $1.20 a year, a 3.0% yield. Ten years later, the dividend is $2.40. Your yield on cost is $2.40 ÷ $40 = 6.0%.

If you bought in several lots, use your average cost per share: 100 shares at $40 plus 100 at $60 is an average of $50, so a $2.40 dividend is a 4.8% yield on cost. With a DRIP, you can measure against your original cash or against your full adjusted cost base, which includes each reinvestment. Both are used; just be consistent.

What does yield on cost actually tell you?

It’s a growth measure in disguise. A rise from 3.0% to 6.0% yield on cost simply says the dividend per share doubled while you held the shares. That’s worth knowing: it shows how much income a past purchase now produces relative to the money you put in.

The table also shows the catch. While yield on cost doubled, current yield stayed around 3.0%, because the share price rose in step with the dividend. In year 10 the market was valuing the dividend the same way it did in year 0.

What does yield on cost hide?

The core problem is that it compares today’s income with yesterday’s price. That leaves several things out.

• Today’s value: in the table, the shares are now worth $80. The income is 3.0% of what you could sell them for, not 6.0%.
• Price losses: a falling share price doesn’t change yield on cost at all.
• Inflation: $2.40 ten years from now buys less than $2.40 today, so a rising yield on cost overstates real income growth.
• Total return: it ignores the price gain, which in the example doubled your capital.
• Risk: a high yield on cost says nothing about whether the dividend is still well covered. The payout ratio speaks to that.
• Comparisons between people: two investors holding the same stock can report very different yields on cost simply because they bought at different times.

How fast does yield on cost grow?

Because yield on cost tracks dividend growth, it climbs quickly when the growth rate is high. Starting from a hypothetical 3.0% yield at purchase, with the dividend growing at a steady rate each year:

Why does opportunity cost matter?

Say you own 500 shares from the example: original cost $20,000, current value $40,000, income $1,200 a year. Yield on cost says 6.0%. But the question behind any decision today is what that $40,000 earns, because $40,000 is the amount you’re choosing to keep in this company rather than anywhere else.

On $40,000, $1,200 is a 3.0% current yield. If another hypothetical holding of similar risk yielded 4.0%, the same $40,000 would produce $1,600. Taxes and switching costs are real and can change the picture, so this isn’t a reason to sell. It’s a reason to compare like with like: current value against current value.

Can yield on cost make a bad investment look good?

It can at least make one look fine. Consider a hypothetical stock bought at $40 with a $2.00 dividend (5.0%). The price falls to $25 and the board cuts the dividend to $1.60.

When is yield on cost useful?

It works as a progress marker: a quick way to see how much a long-held position’s income has grown. It also helps if you think about income in terms of the dollars you originally saved. Used alongside current yield and total return, it’s harmless. Used alone for decisions, it misleads.

Some investors also find it steadying in a falling market: seeing that a long-held position still pays a solid percentage of the original money can make volatility easier to sit through. That’s a behavioural benefit, not an investment signal.

The yield on cost calculator shows both figures side by side, and the dividend growth calculator projects how yield on cost changes under a growth rate you choose.