Yield on cost

From CEOpedia | Management online

Yield on Cost (YOC) is an indicator that determines the dividend rate calculated by dividing the current dividend by the original price of the purchased share. Unlike the current dividend rate, which is the dividend payment rate divided by the current share price, YOC determines the original share price at which the share was purchased. YOC is expressed as a percentage. It is created by dividing the value of the dividend per share by its price. The dividend rate is calculated as the ratio of the dividend paid per share in the last year to the average market price of shares in the audited period. It is assumed that the higher the index, the more attractive the company is. However, it should be remembered that too high a value of this indicator may mean current consumption of profits and lack of perspective approach, which may lead to limiting the company's investment opportunities. Because not all companies pay dividends, this indicator is treated only as a supplement to the fundamental analysis. The dividend itself is defined as the part of the profit that the company does not allocate to investments within the company (as opposed to retained earnings). In other words, these are regular payments, the source of which are profits less the company's expected investment expenditure [1].

Interpretation of yield on cost

YOC is an indicator of the profitability of dividends relating to the original price of a purchased investment, so shares with high dividends, growing over the years, usually have relatively high YOC ratio. For investors pursuing a long-term investment policy of holding shares, YOC may be very beneficial, as, over time, current dividend payments are higher than the initial price paid for the security. Thus, the investor can count on a 100% increase in YOC. When assessing the profitability of dividends, investors should carefully monitor the cost of purchasing a given share over time and the changes in its current prices, especially as the YOC is determined by analysing the ratio of the price paid for the share at the time of its purchase to its current price. To avoid unrealistic indications and overestimation of profitability, all acquisition costs should be included in the cost component of the YOC calculation and no comparison should be made between different companies since shares with a higher YOC are not automatically a more profitable investment option. A company with a high YOC may have a lower current dividend rate than companies with a relatively low YOC [2].

Corporate dividend policy

The decision on the amount of dividend to be paid is made by the annual general meeting (in the case of sp. z o.o., the shareholders). The conditions that must be met for a dividend to be paid are as follows [3]:

  • end of the financial year (except advances that may affect the increase in profit)
  • the preparation of the financial statements (if necessary, audited)
  • approval of the report by the general meeting
  • decision on profit distribution and dividend payment.

Most often, dividends are paid out in cash, although they may also be issued in the form of shares. It is paid out from reserve capital, net profit or undistributed profits from previous years. A decision to pay a dividend results in a reduction of funds which may be used to cover the current activity of the company or investments leading to the development of the company. The amount of profit that is planned to be transferred for distribution among shareholders may not exceed the profit for the last financial year increased by the amounts entrusted to reserve funds in previous years and reduced by the loss suffered and the amounts transferred to these funds, which cannot be directed to the dividend payment. The dividend policy shall determine the rate of retained profit. The increase in the retained earnings ratio is a consequence of the decrease in the net income distributed in the form of dividends. The result is an improvement in sustainable development through an increase in internally generated profit [4].

There are several strategies of dividend payment due to their size and cyclicality [5]:

  • a constant size
  • a fixed rate of payout
  • surplus
  • the target rate of payout
  • the 100% payout rate
  • zero rate of payout.

Examples of Yield on cost

  • Example 1: A company has a share price of $100 and pays a dividend of $5 per share. The yield on cost for this company is 5%, calculated by dividing the dividend by the share price.
  • Example 2: An investor buys 10 shares of a company at a price of $20 per share. The company pays a dividend of $2 per share. The yield on cost is 10%, calculated by dividing the dividend of $2 by the purchase price of $20.
  • Example 3: An investor buys 1,000 shares of a company at a price of $10 per share. The company pays a dividend of $1.50 per share. The yield on cost is 15%, calculated by dividing the dividend of $1.50 by the purchase price of $10.

Advantages of Yield on cost

Yield on Cost (YOC) is an indicator that determines the dividend rate calculated by dividing the current dividend by the original price of the purchased share. Due to its definition, YOC has a number of advantages:

  • YOC allows investors to compare the return on investment of different companies and investments. This indicator is especially useful when comparing investments with different prices, as YOC controls for the price of the share.
  • YOC also helps investors determine whether any changes in the price of the share has affected the dividend rate.
  • YOC is a good indicator of the return of the long-term investment as it takes into account the rate of current dividend and the original price of the share.
  • YOC also helps investors make more informed decisions when considering investing in a particular company. It is especially helpful when deciding between companies with similar dividend rates.

Limitations of Yield on cost

Yield on cost (YOC) is a useful metric for investors when evaluating an investment opportunity, however, it comes with some limitations. These include:

  • It does not take into account the price appreciation of the stock, since it is based solely on the initial price of the stock when it was purchased. This means that stocks that have experienced price appreciation will have a lower YOC than stocks which have not.
  • It also does not take into account the current dividend rate, which may be higher or lower than the original dividend rate.
  • It does not take into account the company’s financial performance and its ability to pay dividends in the future. Companies may pay out higher dividends in the short-term, but may not have the long-term financial strength to sustain higher dividend payments.
  • It does not take into account the risk of the stock, since it does not factor in the volatility of the stock.
  • Lastly, it does not take into account the overall return on investment, as it does not factor in the potential for capital gains.

Other approaches related to Yield on cost

  • Yield on Cost (YOC) is one approach used to analyze the dividend rate of a company. Other approaches related to YOC include:
  • Dividend Payout Ratio (DPR) - This is a metric used to measure the percentage of a company’s earnings paid out to shareholders as dividends. It is calculated by dividing the total dividends paid by the company’s net earnings.
  • Dividend Yield - This metric helps investors assess the rate of return on their investment. It is calculated by dividing the dividend per share by the share price.
  • Earnings Per Share (EPS) - This metric measures the amount of money earned per share of a company’s stock. It is calculated by dividing a company’s net income by its total number of outstanding shares.
  • Return on Equity (ROE) - This metric is used to measure the profitability of a company. It is calculated by dividing a company’s net income by its shareholder equity.

In summary, Yield on Cost is an indicator used to determine the dividend rate of a company, while other metrics such as Dividend Payout Ratio, Dividend Yield, Earnings Per Share, and Return on Equity are all used to measure different aspects of a company’s financial performance. These metrics can be used together to help investors make informed decisions about the dividend rate of a company.

Footnotes

  1. ↑ D .N. Maynard, et al. 2003, pp. 3-6
  2. ↑ S. Shamshiri 2011, pp. 1246-1259
  3. ↑ N. Kantanantha, et al. 2010, pp. 362-380
  4. ↑ N. Kantanantha, et al. 2010, pp. 362-380
  5. ↑ G. Seidman, R. Atun 2017, pp. 29


Yield on cost — recommended articles
Running yield — Plowback Ratio — Profit factor — Degree of financial leverage — Market value ratios — Book profit — Asset equity ratio — Net yield — Bird-in-the-hand theory

References

Author: Hubert Olech

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