Yield on cost

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Yield on cost
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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.

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

References

Author: Hubert Olech