The yield-on-cost calculation measures how much the results from your dividend-paying stocks have improved -- or not -- since you purchased the shares. The focus is on the benefits of growing dividend payments. Reinvesting dividends will affect your yield on cost, but under the strict definition of the calculation, the compounding benefit of reinvesting is not included.
Growing Yield on Your Invested Dollars
As the name makes clear, yield on cost will be the yield you are earning from your stock shares based on what you originally paid for those shares. The formula is the current dividend rate divided by the cost of the shares. The calculation can be done on a per share or dollar total basis. For example, several years ago, you bought 100 shares of a $25 stock that was paying a $1 annual dividend for a 4 percent yield. The dividend has been increased to a current rate of $1.20 per share. Dividing $1.20 by $25 gives a yield on cost of 4.8 percent. Dividing the $120 of dividends you now earn by the original $2,500 invested produces the same yield percentage.
Reinvested Dividends as Principal Investments
Under the definition of yield on cost, reinvested dividends would be counted as additional investments in the stock. To perform the calculation, add up your original investment in the stock plus all of the dollar amounts of the reinvested dividends to determine your total cost basis. The dividend amount will be the number of shares you now own multiplied by the current annual dividend rate per share. Then divide the amount of dividends you are currently earning by your total cost basis.
Value of Dividend Growth vs. Compounding
Calculating yield on cost for your dividend reinvestment account gives you a yield based on a series of investments, including shares purchased through reinvestment. This yield can be compared to the current yield of the stock to see if the dividend increases declared by the company have resulted in a more attractive income stream. With dividend reinvestment, you will buy shares at a range of costs, so the yield on cost provides an interesting indicator of the positive or negative effect of reinvesting.
Yield on Compounded Dividends
You can calculate the yield based on the current dividend earnings divided into just the amount of money you have put into the stock, not including reinvested dividend. The resulting yield shows the combined effect of the growing number of shares from reinvestment and the increases in the dividend rate per share. This yield can be compared to the true yield on cost percentage to see the effect of compounding the dividends.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.