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Don’t Rely on Dividend Yield on Cost

Caution with Yield on Cost

Relying on dividend yield on cost as part of your analysis and investment decision making process leads to decisions being made on irrelevant information. It can also lead to extremely poor investment decisions as borne out by the example I provide about a company which has destroyed shareholder value over the past several years.

 

In my December 11, 2016 Dividend Yield on Cost versus Dividend Yield article I wrote why dividend yield on cost is an inappropriate metric on which to make investment decisions. I continue to see bloggers discuss their investments and to use this as a metric they track. I, therefore, thought I would revisit this topic to demonstrate how the use of this metric is irrelevant and could potentially lead to poor investment decisions.

First and foremost, here are the definitions for both metrics.

Dividend Yield – This financial ratio indicates how much a company distributes in dividends per share on an annual basis relative to its current share price. It is expressed as a percentage and is calculated by dividing the dollar value of dividends paid in a given year per share by the dollar value of one share.

Dividend Yield on Cost – This is the annual dividend per share dividend by the average cost basis of a share; cost basis is defined as the average cost basis of the shares you have acquired over time.

Simplistically, if the number of shares owned by the investor does not change, the dividend yield on cost will increase if the company increases the dividend paid to shareholders. If it does not increase its dividend, dividend yield on cost will remain constant.

In that December 11, 2016 article I used Chevron (NYSE: CVX) as an example. At the time I wrote the article, CVX was trading at $115.81 and the annual dividend was $4.32 thus giving us a dividend yield of 3.73%.

Where do we stand today? CVX is trading at $125.97 and the annual dividend is $4.48 for a dividend yield of ~3.56%. A little bit lower than when I wrote my December 11, 2016 article but still relatively similar.

I then used the example of someone who purchased Chevron for $57 near the end of 2005 when the quarterly dividend was $0.45. Using the dividend yield on cost metric, my yield was 7.58% (($1.08*4)/$57) which is calculated on the basis of the current annual dividend and the historical price. Sounds like I am mixing apples and oranges!

What does the current dividend yield on cost look like? (($1.12*4)/$57) or ~7.85%. Not much of a variance between 7.58% and 7.85% but if we were to revisit this calculation in another 10 years (assuming CVX increases its dividend over this timeframe) I suspect the variance would be far greater.

Here we have CVX that is rated Aa2 by Moody’s and AA- by S&P Global. Both are high grade investment grade credit ratings (Moody’s rating is one notch above that accorded by S&P Global). To think that a company with these credit ratings is generating a dividend yield in excess of 7.5% is flawed. If you were to invest additional money in CVX today you certainly would not be generating a dividend yield in excess of 7% on this ‘new’ investment. In addition, you would be extremely hard-pressed to find a company of comparable credit quality that would provide a dividend yield in excess of 7.5%.

Here is an example using another stock which is my largest holding. The company in question is VISA (NYSE: V). My average cost is $14.8068 and the annual dividend is $0.84/share ($0.21/quarter). Using dividend yield on cost I am generating a return of ~5.67%. There is NO way I am generating a dividend yield of this magnitude.

Sure, I look like a hero if I am generating this type of return on my original VISA investment but dividend yield on cost excludes the time elapsed since my purchase and the impact of inflation. In a very low interest rate environment inflation may not be an issue but as inflation creeps up it will be a factor.

Now, V and CVX have done really well but let’s use an example where you rely on dividend yield on cost where things have gone horribly wrong. I will use Corus Entertainment (TSX: CJR-B) because this company is a ‘real dog’. If anyone reading this owns CJR-B…I hope your investment is minimal.

In my opinion, this company has been a totally inappropriate investment over the past few years for anyone who has been endeavoring to reach financial freedom. This is a financial purgatory investment.

Let’s say you acquired CJR-B shares the last business day of 2013 at $24.73. Back then the company was distributing $0.085/share/month or ~$1.02/share/year. At the time, the dividend yield was ~4.12%.

Fast forward to the present day. The monthly dividend is now $0.095/share/month or $1.14/share/year.

Your dividend yield on cost is now ~4.6%. Not bad. Your yield based on dividend yield on cost has increased and is not setting off any ‘red flags’.

But wait! CJR-B has been an unmitigated disaster that has been unfolding for some time. As I compose this article, the stock is trading hands at $4.05/share. NO….it has not split its shares.

If you look at the current dividend yield you are receiving in excess of 28%. WOW! That might look great but that is a HUGE ‘red flag’.

If you bought 1000 shares at $24.73 and they are now trading at $4.05, you have lost $20.68/share or $20,680 of your principal. If you rely on the ~4.6% dividend yield on cost for your investment analysis, however, you don’t see that this company has gone totally off the rails.

Final Thoughts

I fully recognize that not 100% of our investments are going to be winners. That’s investing!

It is important, however, that we learn from our mistakes. In order to learn from our investment mistakes we need to ensure we are monitoring things properly.

Hopefully this article shed some light as to why using dividend yield on cost is an inappropriate metric with which to monitor your investments.

I wish you much success on your journey to financial freedom.

Thanks for reading!

Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to charles@financialfreedomisajourney.com

Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.

Disclosure: I am long CVX and V. If I were long CJR-B I think I would have committed Seppuku by now.

I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.

By |July 29th, 2018|General Investing|Comments Off on Don’t Rely on Dividend Yield on Cost

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