Drip Portfolio Ignore Splits, Dividends Rock

Johnson & Johnson recently announced its first stock split since 1996, but we don't place much importance on stock splits. We place a great deal of importance on dividends, though. Did you know that you could eventually earn a big 12% annual dividend yield (before considering the time value of money) by owning the right company the next eighteen years? You just need to own a company that increases its dividend a certain amount annually. Also, dividends are responsible for much of the S&P 500's total return.

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By Jeff Fischer (TMF Jeff)
May 17, 2001

Stock splits. They were a dime a dozen in the roaring 1990s. Now they're few and far between.

A company splits it stock to bring the price down to a less intimidating level for more investors, and sometimes it splits the stock to increase the number of shares outstanding and raise trading volume. If a stock trades at $150 per share and it is split 2-for-1, it then trades at $75 per share. Shareholders who owned 100 shares own 200 after the split, but the value of their investment hasn't changed.

That is, unless the stock price rises.

When a split is announced, a stock typically rises on the news, and then sometimes it rises more soon before the split occurs, and immediately afterwards. Why? Well, in normal situations with seasoned companies, a stock split is often an indication from management that it foresees continued prosperity. Beyond that, a splitting stock rises due to a self-fulfilling prophecy: Active traders believe that splitting stocks rise, so they buy them, and thereby push up the price. However, these quick gains are usually retraced by the stock.

On April 23, Johnson & Johnson (NYSE: JNJ) announced its first split since 1996. The stock gained a few points on the news, and since then it has gained 7.7% total, while the S&P 500 has gained 5.4%. J&J is one of the few stocks to announce a split this spring. For this portfolio, the split means that we'll be able to buy more shares with our monthly investment, although because it is percentages that matter, the overall difference that the split makes is trivial to nil.

That's how it is with all stock splits in the end. The news is inconsequential. (That said, if a successful company never splits it stock, it could end up with a share price like Berkshire Hathaway (NYSE: BRK.A) at $67,000.) In a typical split, you receive twice as many shares, but because the price is cut in half, your share value remains the same. So, you might enjoy stock splits, but they're not something to ascribe real value to. In fact, too many splits too close together is usually a sign of bad management.

Johnson & Johnson's stock will split 2-for-1 (on the books) the night of May 22. The stock will start trading at its new split price around June 12. The Fool has a full FAQ on stock splits if you'd like more on the subject.

Dividends are important!
In recent history, dividends have been as respected as a cat at a dog show. While investors crave stock splits, few seem to give a Woodsie Owl hoot about dividends. That's a big shame!

Dividends make up a considerable portion of the stock market's total return. The S&P 500 has returned approximately 7.8% annualized since 1926 without dividends reinvested; with dividends reinvested, it has returned 10.8% annualized. This three-percentage-point difference is gigantic over time. Over forty years at these rates, a $10,000 investment without dividends reinvested will grow to $224,188, while the same investment with dividends reinvested grows to $737,496 -- more than three times as much.

"But those returns are history and dividends today are smaller," you say, "so what about now?"

Well, I believe that now dividends could become even more important to overall performance, partly because I don't believe that most share prices are going far anytime soon. Warren Buffett and partner Charlie Munger believe that over the next sixteen years, the major market indexes are most likely to return approximately 6% annualized. They don't have a crystal ball, but I certainly respect their view, and when I look for value in established companies myself, it's difficult to find. Therefore, for the average investor, I believe that dividends will prove significantly important to earning stronger returns the next few decades.

Plus, if you own a good stock long enough, eventually you could be earning 12% annually, or more, just from dividends alone! That's a heck of an all-but guaranteed annual return. So, how do you get it?

Many successful companies increase their dividend payment each year, often by as much as 10% to 14%. Johnson & Johnson has increased its dividend every year for the past thirty-eight years. If you bought the stock 30 years ago, the dividend yield that you'd earn on your initial shares would have grown by approximately 12% annually (doubling every six years), until today when you would earn a 48% annual return on your initial shares just from dividends alone! Forty-eight percent per year! (For a shorter example, at year eighteen, your dividend return would have been 12% annually. But for both examples, remember the effect of the time value of money. Assuming 4% inflation each year, the net present value of the 12% dividend yield would be closer to 6% of your initial investment annually.)

"That's history," you say again. True, but it isn't too late. Johnson & Johnson, and many other leaders, continue to increase dividend payments annually. J&J just increased its dividend by 12.5% last month.

When Drip Port bought the stock in 1997, J&J paid $0.44 per share in annual dividends (adjusted for the upcoming split). After four dividend increases, it now pays $0.72 per share in dividends, up a big 63% in just four years. We paid a split-adjusted $31 for our initial shares of J&J stock, which means that our dividend yield on those shares is now 2.3%. We're still far from 12% annual income, but we're on the right path. Today, the $99 stock yields new buyers 1.4%; our oldest shares already yield 64% more than that.

We wrote more about the importance of dividends back in roaring 1998. To discuss this column and related investing topics, visit us on the Drip Companies board.

Jeff Fischer owns the stocks held in the Drip Port, including J&J. He also owns 10,000 shares of Berkshire Hathaway. Oh, wait. That's 0 shares, actually. The Motley Fool has a full disclosure policy.

Drip Portfolio

5/17/01 as of ~8:30:00 PM EDT

Ticker Company Price
Daily Price
% Change
CPBCAMPBELL SOUP(0.55)(1.83%)29.45
INTCINTEL CORP0.240.85%28.60
JNJJOHNSON & JOHNSON0.910.91%100.68
PEPPEPSICO INC(0.33)(0.73%)44.93

Overall Return -- total % Gained (Lost)
  Day Week Month Year
To Date
Comparable S&P 500n/an/an/an/a10.42%
S&P 5000.27%3.44%3.12%(2.41%)37.25%
S&P 500 (DA)0.27%3.37%3.06%(2.36%)39.87%

Internal Rate of Return -- Annualized Rate of % Gained (Lost)
  Since Inception (7/28/1997)
vs. S&P 5004.70%

Trade Date # Shares Ticker Cost/Share Price Total % Ret

Trade Date # Shares Ticker Total Cost Current Value Total Gain

• S&P 500 (DA) = dividend adjusted. Dividends have been added to the total return of the index.

Drip Port launched with $500 on July 28, 1997, adds $100 to invest every month, and the goal is to own $150,000 in stock by August of the year 2017. Due to the slow nature of dollar-cost-averaging and our relatively significant starting costs, we do not expect to seriously challenge the S&P 500 for the first three to five years as we build an investment base. The long-term advantages of dollar-cost-averaging still overcome the short-term disadvantages, however. Final note: our investment in Campbell Soup is frozen due to fees instituted in its investment plan. Click here for a history of all Drip Port transactions.