With the market essentially treading water over the past six months, this is an opportune time to revisit one of my favorite investing concepts: yield on cost. This looks at the increase in dividend payments from the point you originally invested.

You probably have a decent enough understanding of how a stock’s dividend yield is calculated. You take the current annual dividend (generally by taking the most recent quarterly dividend and multiplying by four) and divide it by the current share price. But while this will give you a good idea of the cash returns to expect on new purchases, it doesn’t give you much insight into your returns on your original investment, which is what most investors care about. That’s what “yield on cost” looks at.

We’ll consider an example from the Boom & Bust portfolio. Adam first recommended a high-quality, high-dividend paying REIT in May 2012. At the time, its share price was $20.93, and its most recent quarterly dividend was $0.42 per share. That gave the stock a dividend yield of 8.0%.

That’s not half bad. But let’s now take a look at what that REIT pays in dividends today. Adam’s REIT now pays $0.54 per share in quarterly dividends. Annualized, that’s $2.16 per year… or a yield of 10.3% on our original cost basis. Said differently, an investor who bought Adam’s original recommendation would be enjoying 10.3% cash-on-cash returns. And given the REIT’s track record for raising its dividend, I expect more to come.

This REIT has grown its dividend at a 10.4% annual clip over the past 10 years… and at a 10.9% clip over the past five. If you had bought this REIT 10 years ago and held until today, you’d be enjoying an annual cash dividend equal to 15.5% of your original purchase price.

I give you this example mainly to illustrate the power of dividend growth. In a choppy, range-bound market, you can still eke out a decent return by simply letting your dividend payers do what they do best.

Does this mean we should buy and hold, come what may?

Absolutely not. To start, you should constantly reevaluate your dividend-paying stocks for the safety of the dividend. Check their history to see how they fared in past recessions and bear markets. Historical dividend growth will mean nothing to you if the stock’s situation changes and the board is forced to slash the dividend rather than raise it.

Secondly, always remember that bear markets tend to knock down all stocks, even solid dividend payers. So there’s nothing wrong with selling a good dividend payer with the intention of buying it back later at a better price.

You can learn the name of the REIT by subscribing to Boom & Bust, where we’ll continue to send monthly updates on our portfolio.
Charles Sizemore

Charles Sizemore
Research Analyst, Dent Research

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Charles Sizemore
Charles Sizemore is the editor of Peak Income, a monthly newsletter focusing on income and retirement strategies.