Every now and again I believe a reminder is in store addressing the reason and rationale for various approaches we take. One such topic relates to Yield On Cost which can generate passion on both sides of the debate. One side equates this metric as little more than a head fake while the other swears by its’ value. As with most issues, the real answer lies in between. At the very least all sides agree on the definition which per Investopedia is:
Yield on Cost (YOC) is the annual dividend rate of a security, divided by its average cost basis.
opines on the “yield on cost fallacy” by highlighting a common strategy of selling a “winner” to increase current yield. On its face, i get it. There are nagging questions looming under the surface including possible tax impact, transaction fees, the quality of the replacement security and strategic value. In the case of Shaw versus BCE, a strategic value could be rendered on sports teams (content) which BCE has and Shaw doesn’t.
While YOC is generally considered a trailing indicator, Dividend Growth Investor
posits its role as a leading indicator. I can’t say I agree with this theory due to the static nature (barring dividend cuts) of the metric. My belief is that this role is better suited to the Dividend Growth Rate (DGR).
Simply Safe Dividends
presents a balanced view of the pros and cons but cheapens his argument by stating, “Personally, yield on cost does not play a role in my investment decisions or process to build a dividend portfolio.
” This is a no-brainer as YOC can only be derived once the purchase decision is executed.
Let’s review a real example from my portfolio. Comcast became a holding via an exercised grant on November 19th 2002 with a cost basis (adjusted) of $6.69. My YOC is 13.36%. In isolation, I can derive some facts from this metric:
- I’ve derived a nice profit, resulting in
- A tax liability which will be incurred upon sale
- An ongoing 13.36% ROI
It provides no clues as to the current or future prospects nor does it provide an inkling as to the ongoing business viability. For these – and a host other reasons – further due diligence should be performed. I don’t use the YOC alone as a rationale to hold as it is possible to change my allocation to generate greater income. The intangible impacts would be on sector allocation and personal safety required.
Meanwhile, I’m content with the realization that the dividends continue to perform the heavy lifting to deliver a nice ‘feel-good’ result. Care to share your thoughts on Yield on Cost?