While most investors obsess over the "current yield" of a stock, the seasoned dividend growth investor focuses on a different metric: Yield on Cost (YOC). YOC is the ultimate measure of how hard your original investment is working for you today. It illustrates the long-term mathematical impact of combining dividend growth with automatic reinvestment.
Defining Yield on Cost (YOC)
Yield on Cost is calculated by dividing the current annual dividend per share by the price you originally paid for that share .
The Formula:
$$\text{Yield on Cost} = \frac{\text{Current Annual Dividend}}{\text{Original Purchase Price}}$$
In contrast, the Current Dividend Yield is the dividend divided by the current market price .
To understand the difference, imagine you bought a stock for $20 five years ago. Today, that stock is worth $50, and it pays a $1.50 annual dividend.
- Current Yield: $1.50 / $50 = 3%
- Yield on Cost: $1.50 / $20 = 7.5%
The current yield tells you what a new investor would earn today. The YOC tells you what you are earning on the money you actually took out of your pocket years ago.
The "Emma" Case Study: A Lesson in Perspective
To illustrate the power of YOC, consider the story of Emma, a retiree reviewing her portfolio . Fifteen years ago, her manager bought shares of XYZ Corp for $10 each. At the time, the dividend was $0.50, representing a 5% yield. Over the next 15 years, the company raised its dividend by $0.20 every single year.
Today, the dividend is $3.50 per share, and the stock price has climbed to $50.
- Current Yield: $3.50 / $50 = 7%
- Yield on Cost: $3.50 / $10 = 35%
Emma was initially upset when her manager sold the position to buy a new stock yielding 8.5%. She thought, "Why would I give up a 35% yield for an 8.5% yield?" . Her manager had to explain that the 35% was a historical reflection. On a "forward-looking" basis, the money tied up in XYZ Corp was only earning 7% relative to its current value. If she could move that same capital into a different high-quality company yielding 8.5%, her actual income would increase .
However, for the long-term accumulator, YOC serves as a powerful motivational tool. It highlights the fact that dividend-paying stocks have a "growth ceiling" that far exceeds fixed-income investments like bonds. Bonds offer a fixed interest rate that never grows; a 5% bond will always be a 5% bond. A dividend growth stock, however, can eventually reach a YOC of 100% or more, meaning you receive your entire original investment back in dividends every single year .
The Mathematical Impact of Dividend Growth
The "Snowball Effect" is supercharged when a company consistently grows its dividend. This is where the Gordon Growth Model (GGM) comes into play. The GGM is a formula used to determine the intrinsic value of a stock based on its future dividend payments, assuming they grow at a constant rate .
The Gordon Growth Model Formula:
$$P = \frac{D_1}{r - g}$$
- P: Current stock price
- D1: Expected dividend next year
- r: Required rate of return
- g: Constant dividend growth rate
If a company grows its dividend at 7% per year, the dividend will double approximately every 10 years. If you are also reinvesting those dividends through a DRIP, your share count is also increasing. This creates "compounding on top of compounding."
| Year | Shares Owned | Dividend Per Share | Total Dividend Income | Yield on Cost (Initial $10k) |
|---|---|---|---|---|
| 1 | 100 | $4.00 | $400 | 4.0% |
| 5 | 118 | $5.24 | $618 | 6.2% |
| 10 | 148 | $7.35 | $1,087 | 10.9% |
| 20 | 254 | $14.46 | $3,672 | 36.7% |
| 30 | 512 | $28.44 | $14,561 | 145.6% |
Note: This hypothetical table assumes a $100 stock price, a 4% initial yield, 7% annual dividend growth, and 0% stock price appreciation to isolate the impact of the DRIP and dividend growth.
As shown above, by Year 30, the investor is receiving more than their original $10,000 investment every year in dividends alone. This is the "Snowball Effect" in its purest mathematical form.
Why YOC is the "Long Game" Scoreboard
- Inflation Hedge: As companies raise prices to combat inflation, their earnings often grow, allowing them to increase dividends. This helps preserve your purchasing power .
- Psychological Resilience: Seeing a YOC of 10%, 20%, or 50% makes it much easier to hold through market crashes. You realize that the "price" of the stock matters less than the "income" the stock produces.
- Passive Income Goal Setting: If you know you need $50,000 a year to retire, YOC helps you calculate how much you need to invest today to reach that goal in 20 years, accounting for dividend growth.
Frequently Asked Questions about YOC
Q: Can YOC really go above 100%?
A: Yes. If you bought a stock for $10 and 25 years later it pays a $11 dividend, your YOC is 110%. You are being paid more than your original cost every year
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Q: Is a high YOC always good?
A: Not necessarily. A high YOC just means you bought well in the past. You must still evaluate the company's current financial health. If the company is failing and the dividend is at risk of being cut, a high YOC won't save you
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Q: Should I sell a stock with a high YOC?
A: Only if you find a better opportunity. As in the "Emma" example, if your capital could earn a significantly higher current yield elsewhere with the same level of safety, it might be worth moving the money
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