A simple way to show the power of growing dividends
There is a simple and powerful way to show the power of growing dividends over time.
It is called “yield on cost.” Also known as the dividend yield on book value, yield on cost is a fantastic metric that can be used to judge the success of an investment in a dividend-paying stock. It’s calculated simply by dividing a stock’s current dividend rate by the amount paid for the original stock.
Earn money while waiting
At Leon Frazer, we are fortunate to have earned the trust of three generations of clients who, in some cases, have been holding investments for decades. Some of our long-standing clients now have incredibly low cost basis positions that are earning more than the value of their initial investment in dividend payments every year. To illustrate, we calculated several 30-year dividend yields on cost in the table below.
If you purchased RBC shares in 1983, you would now earn over 50% per year on that investment in dividends alone. You will notice we did not include the current price of the shares. Our long-standing clients are savvy enough to not worry about the current price of shares, something that only matters when you are selling your investment. If you took an equal-weighted portfolio of the six companies above, it would return 45% per year in dividends alone. No wonder many of our more experienced clients could care less whether the market is up or down in the past year!
Longevity is the key
The trick to using this metric is holding the investment over a long period of time to see the continued progress. As soon as an investment is sold, most investors never look beyond the cost basis established in the new security. Yet, this somewhat forgotten metric of portfolio performance is extremely relevant to us, given our long-term, low-turnover, buy-and-hold philosophy – a strategy that is becoming increasingly rare these days.
Calculating the dividend yield on the cost of your investment is a cool headed way to evaluate the ongoing health of your portfolio, rather than looking at market values that only capture the sentiment at a specific moment in time. Stock prices are almost never correct at any specific moment for any specific company; instead stock prices tend to reflect intrinsic value over longer periods of time.
The yield on cost metric works over shorter periods of time as well. The following table represents a 10-year time period; with six completely different stocks that are newer additions to Leon Frazer portfolios and carry a 10-year dividend yield on cost of over 11% per year.
Rising dividend streams help manage expectations
A dividend yield on cost that rises over time is a great indicator your investment is performing well. A rising dividend income stream also helps investors manage the unfortunate emotional swings that may tempt them to bail out when they should hang on for the long-term recovery and ongoing dividends.
The holy grail of investing
We invite all of our clients to calculate the dividend yield on cost of both their portfolio and the stocks that comprise it. Using your Leon Frazer Quarterly Portfolio Report, simply divide your total “Estimated Annual Income” with your total “Book Value” and multiply by 100 to get a percentage out of 100. As time goes by, the results may surprise you. The holy grail of this concept is to get an investment that exceeds 100%. The IA Clarington Canadian Conservative Equity Fund, managed by Leon Frazer, holds original shares of Enbridge that were issued at $0.25 per share (split adjusted) in 1953. Those shares currently have a 60-year dividend yield on cost of over 500%. That’s the power of growing dividends!
This article first appeared in the LFA Quarterly Review Q1, 2013.