Much has been written about dividend growth stocks. Investors
are aware of Dividend Aristocrats, Champions, Contenders, and Challengers. They
are familiar with the years each has increased its dividend payments. One,
three, five, and ten-year dividend growth rates are regularly tracked and reported
for these firms and Albert
Einstein’s quote regarding the power of compound interest is a common
refrain with compound growth curves available demonstrating his point.
However, writers and investors seem to miss an important and
powerful factor associated with dividend growing firms: yield on cost. This
metric is different than the oft quoted yield on price, but is still important.
I’ll use rental real estate to illustrate the point. If I
buy a rental property for $100,000 and generate earnings of $200 per month
after expenses during the first year, my return is $2,400 annually or 2.4% of
my initial investment. If I raise the rent and potentially reduce costs in year
two I might earn $300 per month translating into an annual return of $3,600 or
3.6% of my initial investment. In real estate, this yield calculation does not
change if the assessed market value of my rental property goes up or down. My original
investment was $100,000 and my earnings yield is computed relative to that
investment, not floating market valuations.
The same process holds true of returns on dividend paying
firms. If I buy a stock for $50 paying $2 a share in annual dividends the first
year I own it, my yield is 4%. If the company increases its dividend to $2.50
in year two, I still paid only $50 for that share. Consequently, the yield on
my cost is 5% irrespective of stock price fluctuations along the way. This calculation
is true of stocks just as it is rental real estate.
Why is this important for dividend investors? It means yield
on the cost of the stock can increase significantly through persistent dividend
increases given extended holding periods.
This is true even if those increases are small.
Below are examples culled from the Dividend Farmer
portfolio. The yield on price was harvested from Yahoo! Finance in December
2019 and is shown relative to the yield on cost reported by my broker the same
month. Obviously, short-term fluctuations cause these spreads to vary slightly,
but the variances are minor relative to the spreads shown resulting from long investment
periods.
|
Company
|
Yield on Price
|
Yield on Cost
|
Difference
|
|
NNN
|
3.8%
|
9.6%
|
5.8%
|
|
MO
|
6.7%
|
15.9%
|
9.2%
|
|
T
|
5.3%
|
6.2%
|
0.9%
|
|
PFE
|
3.9%
|
10.2%
|
6.3%
|
The average difference between the yield on investment cost
vs current stock market price is 5.55%. Consequently, invested dollars are
working harder than given credit when paying attention only to the yield on
price. If you had the chance to invest in an opportunity today that paid 3.8%
or 9.6% given the same price and risk profile, which would you chose?
Investing $10,000 for 10 years compounded at 3.8% annually results
in $14,520 at the end of the period. Conversely, investing the same amount for
the same period at 9.6% generates $25,009. The 72% increase in return is
compelling and could be yours for staying the course.
Finding an investment yielding 9.6% with limited risk is
challenging. Buying a dividend growth
stock today yielding 3.8% gives you the chance to grow it into a future
investment paying a much better rate.
This is true only if you have the time and patience to cultivate it.
“Someone’s sitting in the shade today because someone
planted a tree a long time ago.” Warren Buffett
Plant a tree on your Dividend Farm today, watch it grow, and
enjoy the shade during retirement. Yield on cost represents the power of
dividend growth. Make use of it when you
can.
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