Yield on Cost and Other Investing Terms
I’ve previously talked about the Dividend Reinvestment and Dollar-Cost Averaging spreadsheets that I made available on Google Docs.
Today I made additions to them, including a Definitions sheet describing some of the more technical terminology that I’ve used. As always, remember that I’m trying to do my best to make sure the investing information is accurate, but please do your own research as well.
Compound Annual Growth Rate: The year-over-year growth rate of an investment over a specified period of time. CAGR isn’t the actual return, but rather the rate at which an investment would have grown if it grew at a steady rate. It is calculated by taking the ratio of the ending value beginning value and raising it to the power of 1/(# of years invested), then subtracting 1 from the resulting number. This helps you compare growth rates of various stocks over an comparable timeframe. For example, a 30% increase sounds great. But that kind of a gain over 2 years is much different than if that gain took 10 years. Source: http://www.investopedia.com/terms/c/cagr.asp
Yield on Cost: The income yield on past investments. It is based on the price you initially paid for a stock. Each share purchases the same amount of dividend per share. However, the only way for the yield on cost to be identical is if the shares were purchased at the same price. As the dividend increases, the yield on cost goes up. Let’s use imaginary company ABC as an example. In 2005 the annual dividend was $0.80. With its current share price then of $40, its yield would be 2%. Okay, but not the greatest. ABC has grown by 3% per year for the last 6 years. It also has a 25 year history of increasing its dividend and the last 6 years have been no exception; ABC has increased its dividend payout by 8% per year. By 2011, ABC’s stock is at $46.37. Its annual dividend is $1.18. Current yield is $1.18/$46.37, or 2.54%. If I were to buy the stock now, that is what I could expect. However, my yield on cost is quite a bit better. Remember, it is based on my original cost of $40. Yield on cost is current annual dividend / price you paid. $1.18/$40, or 2.95%. It is calculated separately for each lot of shares purchased. A great source of information on this topic is available here: http://seekingalpha.com/article/229816-how-yield-on-cost-works
Yield on Total Capital Invested: This is something more specific to reinvested dividends. It makes the assumption that dividends are essentially “free money.” This obviously isn’t true. Dividends count as capital gains and contribute to the cost basis. This formula should not be used when calculating capital gains or losses for tax purposes. That said, if you think of dividends as free money then the total capital would be the stock purchases other than those that came from dividends. It shows the effective yield putting the compounding power of dividend reinvestment into display. It is calculated by the total # of shares * current annual dividend / capital investments. The capital gains from dividends are specifically not included. http://seekingalpha.com/article/229816-how-yield-on-cost-works#comment-1255168