The YouTube video that started it all. Back in 2017, I filmed a video at The Bay Club Redwood Shores about How to Yield 20+% On Cost. This was one of my more successful videos from my early days on YouTube.
Back then, I used a hypothetical example on the whiteboard to explain the concept. The idea: A smaller starting yield can eventually turn into 20% on-cost, or more. How? The investor’s purchase price is fixed/constant, but dividend payments can increase over time, for the highest quality dividend stocks. Simply hold for the long-term and let time pass, while dividend increases keep accumulating. (The hard part: Actually having the willpower and patience to endure long periods of waiting for the magic to happen.)
If you have not seen it yet, you just got to check out my OG PPC Ian video:
What Is Dividend Yield?
The highest-quality dividend stocks out there tend to pay quarterly dividends here in the United States. Each dividend payment represents a portion of the company’s earnings that the Board of Directors returns to shareholders. Loyal shareholders deserve a portion of the profits, right? That’s why the company is in business, after all. (Side note: We want the company to retain some of the earnings to reinvest into future business growth. But, we also want some level of dividends being paid to keep the team shareholder/profit-focused, in my humble opinion.)
Let’s look at a hypothetical stock with ticker PPCIAN. Let’s say PPCIAN trades at $100/share and offers an $2/share quarterly dividend. PPCIAN then offers a starting dividend yield of ($2*4)/$100 or $8/$100, which equals 8%.
Dividend yield is a measure of how much cash flow the investor receives from an investment in any given year. (Side Note: Investors can use dividends to pay real world bills!) It’s a similar concept to interest from a savings account (or a CD account). However, there are two keep differences. Qualified dividends (here in the US) are taxed as long-term capital gains (generally viewed as advantageous), while savings account interest income is taxed as ordinary income (generally viewed as less advantageous). And, dividends in the best companies tend to grow over time, while interest is generally range-bound.
What Is Dividend Yield On Cost?
Let’s say, over time, that hypothetical company/stock PPCIAN grows its profits, on a consistent basis. Each year, profits grow. In year 1, let’s say earnings are $10/share. Remember, the year 1 dividend was $8/share? PPCIAN paid out the majority ($8/$10=80%) of earnings in the form of dividends. This 80% metric is called payout ratio. (Side note: Payout ratios tend to vary by company and by industry. 80% is considered a higher payout ratio, but I use this as a hypothetical example because the real stock discussed later in this post tends to have payout ratios in this general range.)
Let’s now zoom out to year 5. Over the course of 5 years, PPCIAN manages to grow profits to $20/share. Because profits have increased, the (somewhat efficient) stock market has rewarded shares of PPCIAN with a price increase (all the way up to $200/share). Maintaining its 80% payout ratio, PPCIAN’s quarterly dividend grows from $2/share to $4/share over these 5 years.
If someone buys in year 5, they pay $200/share. Since dividends are $4*4=$16/share, the starting dividend yield in year 5 is $16/$200=8%. Interesting, since the share price has increased with earnings, the starting dividend yield has remained consistent over the years. (Side Note: This truly shows the value of time and the value of buying earlier. Time is generally on the investor’s side, when it comes to high quality dividend growth stocks.)
Remember, in this hypothetical example you were smart enough to buy 5 years ago at $100/share? Key Point: Your share acquisition price does not change, it’s fixed in time. Dividends/year are now at $16/share. While your acquisition price is fixed, dividends per share can grow over time, and they have in this example. So, your dividend yield-on-cost has doubled all the way to $16/$100=16%. This is the power of dividend growth investing. This is the power of dividend yield on cost.
What I describe here is referred to as simple yield on cost. It assumes that dividends are just spent over the years. The model gets even more impressive with dividend reinvestment. A model of true dividend yield on cost would provide even more impressive results because dividends are used to buy even more shares (which pay dividends). All of this is part of the dividend snowball concept which spans three major pillars: 1) dividend increases, 2) dividend reinvestment, and 3) net new capital invested.
Today, however, I want to keep it simple, with the concept of simple yield on cost. Simple yield on cost is impressive all on its own without all the extra bells-and-whistles.
Unlocking 25.5% Simple Dividend Yield On Cost
So, remember I started this post with a reference to my early (hypothetical) video from 7 years ago? I’m so excited because I just crossed a major (realy world) milestone in my portfolio. I bought Altria (MO) at a value price back in 2009 and held all these years (about 15.75 years so far).
I’m now yielding a staggering simple 25.5% on-cost with my initial tranche of Altria shares from 2009. Things have come full-circle, a bit. I started out with the theory, back in the early days of this YouTube channel, and now I’m able to share a concrete example of dividend yield on cost working in the real world.
The greatest lessons I have learned over the years, as it pertains to yield on cost are as follows:
- Understand the math and the theory. It can keep you very motivated when others are shouting, “Sell, the market’s crashing.”
- Time is your best ally in the stock market. Think in terms of decades, not years.
- Have realistic expectations. Dividend increases are not always linear because business profit growth is not always linear. There will be periods of fast growth and periods of slow growth. The dividend will (generally) only increase when earnings increase.
- Ignore the haters, and focus on YOU.
- Buy and hold, tune out the noise. The day-to-day volatility does not matter. We invest in dividend-paying stocks so we can enjoy life. Get out there and enjoy the real world. Or, at least focus on something productive such as earning more income to deploy. Obsessing over stock prices and sensational news media are disempowering.
- Reinvest if you can, it only accelerates the dividend snowball effect.
- Add more capital, if you can, as it also accelerates the snowball.
- Keep living expenses low, and avoid lifestyle inflation if you are lucky enough to earn more income over time.
- Stay in great health so you can enjoy your massive dividend income of the future.
- 1Build a really solid emergency fund so you do not risk tapping into your dividend portfolio when inevitable emergency expenses arise. I view this as building a moat of defense around my dividend stock portfolio.
- Always prioritize YOU and your family.
- Check out my YouTube Channel, PPC Ian, for over 400 videos about dividend stock investing. I’ve been at this a long time, and I share my real world journey on YouTube for all to see.
I hope you enjoy my brand new video highlighting my experience yielding 25.5% on cost:
DISCLOSURE: I am long Altria (MO) and Starbucks (SBUX). I own these stocks in my personal dividend stock portfolio.
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Because the information herein is based on my personal opinion and experience, it should not be considered professional financial investment advice or tax advice. The ideas and strategies that I provide should never be used without first assessing your own personal/financial situation, or without consulting a financial and/or tax professional. My thoughts and opinions may also change from time to time as I acquire more knowledge. These are, as discussed above, solely my thoughts and opinions. I reserve the right to delete any comments for any reason (abusive in nature, contain profanity, etc.). Your continued reading/use of my YouTube Channel, blog, email newsletters, whitepapers, Excel files, and other materials constitutes your agreement with and acceptance of this disclaimer.
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