Dividends Recap
And some impressive numbers

by Ann Coleman
(TMF AnnC)

Reston, VA (April 23, 1999) -- Dividends are rather out of fashion these days, what with "dot-com" stocks doubling every other day and complaints about having to pay higher taxes on dividends than on capital gains. Will fashion's fickle finger again swing in their direction?

Maybe when people start wearing their underwear back under their outerwear (not that there's anything wrong with that!).

Or maybe never. Then again, how popular dividends are really depends on three things: Market returns, tax laws, and interest rates.

Right now, as I'm sure you've noticed, the market has been growing rather strongly. When investors start expecting capital gains in the neighborhood of 20% to 30% per year, a 2% dividend gets lost in the glow. Tax laws definitely favor long-term capital gains over dividend income, and, believe it or not, interest rates are actually a bit high right now when you compare them to the inflation rate. (Traditionally, very low-risk interest rates such as 1-year US Treasury bills run about three percent above inflation, which is around 1.5% right how.)

All of these factors are very much subject to change. Lower interest rates would make our 2% to 3% dividends look a lot more attractive to conservative investors, and one of these days Congress might get reasonable about taxes on dividends and interest and decide to reward savers rather than penalizing them. And, as we all know, the market is unlikely to continue to grow at 25+% a year forever.

But since I don't do predictions and am not a slave to fashion, let's look at what has happened rather than speculating about what might or might not happen. The past is certainly not a predictor of the future, but it's better guide than most of the crystal balls the Wise consult.

Consider the impact of dividends in a hypothetical Foolish Four retirement account started in 1980 (not all that long ago, folks!). For simplicity, we are going to assume a $10,000 initial investment with no additional contributions, although that's not exactly typical. It will let us compare these numbers directly with the Exxon (NYSE: XON) example we explored on Wednesday, though, and adding to the account over time would only improve the results.

A $10,000 investment in the Foolish Four stocks, reinvested yearly from 1980 through 1998, would be worth about $690,000 right now. Close to $150,000 of that total is due to the dividends paid. Note that this is very different from investing in something that paid dividends (or interest) only. Starting in 1980, a $10,000 investment in something that paid the same interest rate as the average Foolish Four dividend would have grown to about $33,000 by now -- not $150,000. The difference is that the dividend-only investment is reinvested each year at a much lower rate of return. The average dividend yield was 6.48%. But each year the Foolish Four strategy reinvested those dividends into something that was growing at almost 25% a year, mostly due to capital gains. Big difference.

Now, lets compare the Exxon buy-and-hold investment we discussed Wednesday with the Foolish Four. $10,000 invested in Exxon in 1980 was worth right around $100,000 today and was paying the investor $2,100 in dividends each year. That total assumed that dividends had been pulled out of the account each year, since we were looking at Exxon as an income-generating investment. Had the dividends been reinvested (say, using a Drip), the value of that $10,000 would have grown to almost $300,000, and the investor would have somewhere around 3,700 shares. His annual dividend check would have been closer to $6,000 instead of the $2,100 he was getting. As always, money you spend today can't grow for tomorrow.

But what about the Foolish Four? That same $10,000 invested in the Foolish Four in 1980 would be worth about $690,000 today, remember? So even with today's low average dividend yield, 2% of $690,000 is $13,800 a year in dividends alone.

Too good to be true? Well, it looked that way to me, so I went back and checked the math a different way. Yep, $10,000 invested in the Foolish Four with dividends reinvested (you don't even have to try to reinvest them as they are paid -- you just hold them until you renew each year) would have grown to $690,000 by the end of last year. And that is in spite of a 17% loss in 1990 and a fairly crummy year last year!

As for dividends, the Foolish Four investor is receiving 38% more in dividends every year than the amount of his initial investment.

Wow. Even I am impressed.

Monday, let's talk about why it works -- but this time, I don't mean numbers, I mean investor psychology.

Fool on and prosper!

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Today's Stock Lists | 1999 Dow Returns

04/23/99 Close
Stock  Change   Last
CAT  +   3/4   60.56
JPM  -3  1/16  139.56
MMM  +   7/8   80.81
IP   +1 13/16  55.13

                Day   Month    Year   History
        FOOL-4   +0.84%  22.43%  25.91%  27.78%
        DJIA     -0.35%   9.23%  16.81%  16.35%
        S&P 500  -0.15%   5.48%  10.70%  10.97%
        NASDAQ   +1.14%   5.24%  18.15%  19.77%

    Rec'd   #  Security     In At       Now    Change

 12/24/98   24 Caterpillar   43.08     60.56    40.58%
 12/24/98    9 JP Morgan    105.51    139.56    32.27%
 12/24/98   22 Int'l Paper   43.55     55.13    26.58%
 12/24/98   14 3M            73.57     80.81     9.84%

    Rec'd   #  Security     In At     Value    Change

 12/24/98   24 Caterpillar 1034.00   1453.50   $419.50
 12/24/98    9 JP Morgan    949.62   1256.06   $306.44
 12/24/98   22 Int'l Paper  958.12   1212.75   $254.63
 12/24/98   14 3M          1030.00   1131.38   $101.38

              Dividends Received      $29.45
                             Cash     $28.26
                            TOTAL   $5111.40