Monday, September 21, 1998

The Dividend Growth Fribble
by Selena Maranjian

Dividends get a bad rap sometimes. Or at least, like Rodney Dangerfield, they don't get too much respect. This is understandable, as many Foolish investors, turned on by technology, focus on fast-growing stocks of computer companies, Internet enterprises, and the like -- companies that don't pay much in the way of dividends.

Thinking of venerable blue chips as stodgy and old-fangled, it can sometimes be easy to ignore companies like Ford, Bell Atlantic, J. P. Morgan, and Chevron. But companies like these pay out generous dividends. At the time of this writing, Ford's dividend yield (annual dividend divided by share price) is 3.6%. Bell Atlantic's is 3.5%. Chevron's: 3.2%. (If the thought of tobacco companies doesn't set you to coughing and cringing, Philip Morris is offering an attractive 4%, while RJR Nabisco Holdings sports an eye-popping 8.9% yield.)

Why should a Fool consider a stock that pays a dividend? Well, consider a market downturn. Consider a year, or several years of little or no stock appreciation. Perhaps even depreciation of the prices of your stock. If you bought shares of Ford when the dividend yield was 3.6%, that means you're pretty much guaranteed a 3.6% payout every year, regardless of what happens to the stock price. (Struggling companies have been known to decrease or eliminate their dividends, but they try like heck not to, because it looks really bad.) If you bought $10,000 of Ford stock, you can expect $360 each year. If it doesn't sound like much, note that in three years, you will have received more than $1,000. In 28 years, you'll have earned your $10,000 back. (Of course, if you invested each $360, you'd break even a lot sooner than 28 years.) In addition, in 28 years, a solid company like Ford is likely to have continued growing (albeit perhaps not as briskly as Microsoft or America Online). Couple the stock's price increase with the reliable dividend payouts, and you've got an appealing combination.

But wait -- there's more! Here's something that investors rarely think about. Let's say that you bought 10 shares of a $100 stock that paid out a respectable 2.5% dividend. (Let's say that it's Iditarod Express (ticker: MUSH), "For when it absolutely positively has to get to a remote corner of Alaska in a few weeks.") With a $1,000 investment, that 2.5% means an annual payout of $25. Not bad.

But... if you're a truly Foolish long-term investor, you're going to hold that stock for decades (assuming it remains a robust, growing, wonderful company). Dividends aren't static and permanent. If the Alaskan delivery business continues to grow and Iditarod's revenues and earnings keep growing, it is likely to increase its dividend. Companies do this regularly. Let's say that Iditarod's $2.50-per-share dividend gets hiked to $3.00 per share. Remember -- you bought your shares at $100 each. So on that $100 investment, you're getting $3.00 back now -- your dividend yield has increased to 3%. A few years down the line, perhaps MUSH is trading at $220 per share. If the dividend yield is still 3%, that means it's paying out $6.60 per share. Note: that $6.60 is a 3% yield for anyone buying the stock at $220, but since you bought it at $100, to you it's a 6.6% yield. (Whee!)

Time passes. Federal Express perhaps goes out of business, trying to compete with the likes of Iditarod Express. A decade or two passes. The stock price rises steadily, and splits thrice. Your initial 10 shares are now 80 shares, each currently priced at $120. That means your initial $1,000 investment is now valued at $9,600 -- bravo! Let's say that the yield is still 3%. It's paying out $3.60 per share. But since you've got 80 shares, you receive a whopping $288 per year. Think about this. you're earning an annual $288 on a $1,000 investment. That's 29% per year (and growing) -- without even considering any appreciation of the stock price. The yield for you has gone from 2.5% to 29% all because you just hung on to those shares of a growing company. That's security, Fool! Let the stock price drop, even. You're still likely to get that 29% payout.

This is the magic going on behind the scenes for Foolish investors who bought shares of Coca-Cola decades ago and held on. With many great dividend-paying companies, by holding on, your dividend yield keeps rising.

One more thing you can take advantage of is dividend reinvestment. We often ignore dividend reinvestment plans ("Drips"), thinking they're just for those who can only afford to invest small sums regularly. If so, we're forgetting those very important words: dividend reinvestment. If your stock has been kicking out dividends for decades and you've been reinvesting them back into more shares of the company (something done automatically via Drip plans), then they, too, end up spinning off dividends of their own. Your investment becomes a veritable cash machine. You can end up living off your dividends alone.

It might be hard to see this happening in our real-money Drip portfolio, as it's still so young. But give it a few decades and you'll see. Read more on Drips at our Drip Portfolio area (it contains general info and also nightly reports), and check out our Drip message board, as well.

Jeff Fischer and Phil Weiss recently explored some of the ideas in this piece in Drip and Cash-King portfolio reports. One incredible point Jeff made is as follows:

"One share of Coca-Cola in its first year has become 62,500 shares through stock splits and dividend reinvestments, and the investment is now earning an annual dividend of $37,500. Yes, an initial $40 investment now earns $37,500 in dividends alone every year."

Fool away!

[Hey Fools, why not pen a Fribble, yourself? We welcome submissions from readers. Just click here and read the "What's a Fribble?" item, pen a short masterpiece, and send it off to TMF]

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