Dividend Companies: Yield on Cost Doesn’t Matter

Karin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

OK, I’ve seen several dividend websites write about the importance of yield on cost, and why it is more important than a company’s current yield. And I’ve read these articles, and tried to understand their arguments. But I have to admit, I am completely baffled.

The argument that you should hold onto a company with a high yield on cost, rather than selling it and buying something else that may have a higher current yield, makes zero sense to me.

I don’t care what my yield on cost is – all I care about is the current yield, which is WHAT I AM CURRENTLY MAKING FROM THIS COMPANY. If what I am currently making is lower than what I could be making with another company, then it is time to make the change.

One Example

For example, my favorite dividend company right now is Cracker Barrel Old Country Store (NASDAQ: CBRL). When I first chose this company for my Perfect Dividend Portfolio, back in January, the yield was 3.1%. Since then, the price has appreciated by over 50%, which dropped the current yield to 2.6%.

Now, my yield on cost is still 3.1%; but why on earth would I want to keep it in my portfolio if I could replace it with something that has a higher current yield? Especially if, in doing so, I am locking in 50% gains with which to buy more shares of a company with a higher current yield?

I could sell the Cracker Barrel shares today, and with the cash I could buy a stock that is yielding 3.1%, and net out with approximately 50% in additional dividends annually.

Fortunately for me, Cracker Barrel just announced a 50% increase in their dividend, which brings it back to a 3.1% current yield, and makes me very happy that I don’t have to sell one of my favorite companies. Note that this also brings my yield on cost to 4.6%, but this is an irrelevant metric in my mind.

Another Argument?

Now the prevailing argument for yield on cost seems to be that it works over longer periods of time – for example, I saw one article written about buying 3M (NYSE: MMM) in 1988 at a share price of $16 and a yield of 4.0%. Fast forward 25 years, and 3M is trading at $111 with a current yield of 2.3%.

The investor’s yield on cost is a staggering 16% BUT why would you hold out for 2.3% current yield? By selling the 3M shares and buying something that yields 4%, you can increase your annual dividends by 74%.

Comparing One Company to Another

The yield on cost metric makes slightly more sense to me when used in the context of comparing two companies and their dividend payments over time.

In the article I was reading, the example shows two dividend-paying companies, Coca-Cola (NYSE: KO) and Royal Bank of Canada (NYSE: RY), during the time period from 1997 to 2006. During that time, Royal Bank kept its dividend stable at 3.3%, while Coca-Cola increased its dividend from 1.1% to 3.2%.

At the same time, however, Royal Bank increased in share price from $8.59 to $38.44, and Coca-Cola decreased from $51.13 to $39.36.

So the ultimate result is a yield on cost of 14.8% for Royal Bank of Canada, and 2.4% for Coca-Cola, clearly demonstrating that Royal Bank of Canada was the superior stock to be holding during that time period.

But it’s easy enough to notice the share price appreciation over the years, and the yield on cost is simply an extra and unnecessary calculation, in my opinion.

Realty Income’s Argument

Even one of the big dividend paying companies, Realty Income (NYSE: O) (actually a REIT and not a company, but let’s not quibble), makes the argument for yield on cost on their website.

The site demonstrates what a long-term position in Realty Income has generated in the way of dividends and share-price increases, if an investor had started in 2003 with a $20,000 initial investment.

You originally purchased your shares at a dividend yield of 6.0%. Today, the yield on the original cost of your shares is 10.9%, based on continuous dividend increases. This means that to secure annual income of $2,175, with $20,000 invested, you’d have to find an investment providing a 10.9% yield

True. However, the current yield of Realty Income is 4.9%. If an investor wanted to sell the appreciated shares and re-invest in another company, he would have approximately $45,000; if he found another company yielding 6%, as Realty Income did when he first invested, he would be making an additional 25% in dividends annually, versus holding the Realty Income shares.

Conclusion

I don’t care what a company’s yield on cost is. I care only what it is delivering NOW. If I can find something that will deliver better, than I will not hesitate to sell and buy into something new.

I can be persuaded that I am wrong, but so far I have not seen an argument with which I can agree. Yield on cost just doesn’t matter.

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Karin Hernandez is long Cracker Barrel Old Country Store. The Motley Fool recommends 3M, Coca-Cola, and Cracker Barrel Old Country Store. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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