Individuals need to set a goal in order to succeed at anything, including our individual investments. Logically, the next step is to determine how we are going to measure our progress. In the realm of investments, most the individual investors (if not all investors) look at annualized returns and compare it with benchmark index. Here in India investors either use BSE’s Sensex Index or NSE’s Nifty Index. In addition, based on multiple discussions I have with individual investors, many investors use percentage based capital appreciation or depreciation which is devoid of time concept i.e. no time scale is involved.
For example, investors love to say “I made 150%, 200%, or 2x or 3x, or 0.5x times my money”. I cannot comments whether this progress measurement is right or wrong because I do not know individual’s objective and/or risk profile.
Ironically, of the many folks I have talked to in last ten years, more than 95% of them have always increased their original capital. Well if that’s the case then who is loosing it? If nobody is loosing, then why the market is more than 50% down from its peak. I am digressing from the subject, so coming back to the topic of measuring our progress……
One of primary objective of my income portfolio is to generate income, i.e. passive cash flow. As always, the key is to minimize investments and maximize income. I have been focusing on dividend-based investments. In my income portfolio I have multiple set of matrices to measure my progress. One of the metrics I track is “Yield of Cost” or YOC. It is a very simple metrics but very powerful. YOC is calculated as:
YOC = [(annual dividends per share) x (no. of shares)] / [Cost Basis]
Cost Basis takes into account the purchase price and all taxes (i.e transaction, service, commission, etc).
I have had on an off discussion with folks, (professional and amateurs alike), and they find it really hard to understand the concept of YOC. The argument is YOC is an irrelevant metric. What is its significance and purpose when one can multiply the capital twice or thrice in few months time period. Even if the investment is income focused, current yield is what matter the most and not YOC. YOC is based on timing of the investment, always remains fuild, and cannot be used for relative comparison. Perhaps those are correct from one viewpoint, but let us see some examples of my investments…..
I invest in securities that provide dividend income. In addition, I focus on corporations those have steadily growing earnings (if not leaps and bounds). My expectation is as Indian economy continues to grow; these corporations will slowly and steadily continue to increase their dividends. Even if they do not grow the dividends, perhaps they will maintain some consistency. More on this in future post. For my objective, YOC is optimal measure of progress in reaching my goal. I am discussing about three of my investments viz. ONGC, LNT, and NTPC.
1. I purchased ONGC in year 1999. My cost basis is Rupees 102.9. As shown in table, at the time of purchase my YOC was 5.3%, much lower than a risk free savings account of approximately 7%+. I have not made any investment in ONGC since then. I continue to hold my 1999 position. We can see how my YOC as consistently increased and now in 2008 YOC stands at 31%. Now which investment will give me 31% annualized return on my investment?
2. I purchased LNT in February 2001. My cost basis is Rupees 261.4. As shown in table, at the time of purchase my YOC was 2.5%, again, much lower than risk free savings account. My YOC for this batch of investment in LNT is 5.7% in year 2008. As time progresses, I expect this YOC to grow further.
3. I purchased NTPC in March 2005. My cost basis is Rupees 93.5. As shown in table, at the time of purchase my YOC was only 1.3%, again much much lower than risk free savings accounts. At the end of year 2008 (i.e. only after 4 years), the YOC on my investments has increased to 3.7%. Here also, I expect this to grow as time progress.
Note I have not yet taken into account the potential increase in the value of my investment. All of these original capital investments have now increased by significant amount.
Another way to look at it is: Total dividends alone paid by ONGC is 252% of my original capital, LNT has already paid me 45% of my original capital, and NTPC has already paid me 14% of my original capital. I will leave up to readers to figure out what would be the total return including dividends and today’s value these stocks.
If one were to judge these investments solely on current yield, then they would virtually on relative basis be similar to when I had bought them. However, based on my original investments, the YOC (and hence my income) is growing continuously every year. The primary reason for this growth is corporation’s increased earnings and hence increased dividends.
Now you know why I use YOC to track the progress of income portfolio. I expect my YOC to grow over time. At the time of this writing, I have 12 equity investments in my income portfolio. While the YOC for individual equities is quite different, my YOC for whole income portfolio is at 4.9%.
In my future post, I will discuss why I choose dividend-based equity income over a safer risk free savings account.
So what do you think about Yield-on-Cost?
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