Buying companies that deliver a good dividend yield is one thing but those dividends need to be actively re-invested to generate superior returns.
Take for example the Altria Group (MO).
10 years ago Altria (MO) shares were trading at $6.03, meaning that for $1,000 you would have been able to purchase 165 shares in the tobacco giant. Your 165 shares would today be worth $3,877 and you would have earned to the end of full-year 2009 another $4,054 in dividends. That means your $1,000 would now be worth roughly $7,931. Not bad going for 9 years.
Let's assume however that you had, every time you accrued $1,000 in dividends, you would re-invest them in Altria (MO) stock.
From 2000 to 2002, it would have taken you three years to accrue $1,102 in dividends, which you subsequently reinvested buying you another 111 shares.
On your now enlarged 276 shares it would take you two years to add another 90 shares to your portfolio courtesy of the re-investment. For the purposes of simplicity, we have excluded trading costs as these will vary from broker to broker.
In 2005, 2006 and 2007 you as the investor would have been able to add new shares to your Altria (MO) holding each year, purely on the value of the dividends generated.
By the time 2008 rolled around, you would now have a portfolio comprising 561 Altria shares. Even when the dividends were cut sharply in 2008 and 2009 you would still take home $942 and $740 respectively.
If you re-invested these amounts at the end of the 2009 into Altria (MO) shares you would end the calculation with 632 shares in Altria (MO) which would today be worth $14,852.
You would have enjoyed $8,307 in dividends alone which would trump what you made from your original $1,000 investment in total.
What the above example highlights is that it is not enough for investors to simply buy good dividend yielding stocks and forget about them. For the best long-term returns, these dividends need to be actively re-invested to generate superior returns. Another aspect which is highlighted by the above example is that while the initial investment takes three years to get going, if the dividends continue to grow and you get a mixture of capital appreciation and regular dividends then your share portfolio will grow as the effect of compounding kicks in.
Comments
Clinton Weir
September 28, 2010
Is this assuming the stock is bought with a DRIP? Because I have found that the stocks that I have a DRIP for always seem to reach their local maxima right when the reinvestment takes place. Since my capital is relatively small, and considering the execution fee, this is still better than taking the money and reinvesting it when the price is more favorable. But it certainly is frustrating. A while back I was in YUM and they took a beating on the day I thought I was getting my drop (get it? Drip, drop) but it turns out the purchase did not take place until the next day, by which time the stock had rebounded.
Is this review helpful? Yes:0 / No: 0
Benhubb
September 28, 2010
That will happen, but if you stay long term and patient it will all average out in the end. It is the power of compount interest over time. Also, one thing this article does not mention is the tax. You are still required to pay tax each year on your dividend gains regardless if you re-invest them in a DRIP. So if you make $10,000 a year you can expect to pay 20%+ soon with the Obama Administration hiking the rates. Due to the fact that you have them in a DRIP you will have to rely on your own income to pay the taxes. What I have done is taken my largest payout and converted it to a cash dividend. I withhold 30% of the payments for it's very own tax, and use the remaining 70% to pay the taxes on all the other stocks I own that are enrolled in a DRIP. It may limit growth slightly, but is the best way I can find short of taking out a loan. However, if you make enough money from your main source of income and you can afford to pay the additional taxes each year, then you are in good shape!
Is this review helpful? Yes:0 / No: 0
RomeoWhiskey
September 28, 2010
And...your calculations about MO don't take into account the dividends you would have received from PM when MO spun off PM.
I've been doing dividend reinvestment with MO and subsequently PM since 1994 and am quite pleased with the results.
When the share price gets 'hammered' like it did when Clinton took on the tobacco industry...I got 100's of EXTRA shares. MO's price dropped from the low 60's down to 18. Yes sir...3x the number of dividend shares which have fully recovered. Thanks, Bill.
Is this review helpful? Yes:1 / No: 1
Brian
January 30, 2011
Anyone interested in investing in PM or MO should read Jeremy Siegel's "The Future for Investors". It is an easy read and it will make you want to buy more and more MO and PM.
Is this review helpful? Yes:0 / No: 0
Add your Comment
or use your BestCashCow account