It wasn't until the mid-1990s that I learned about dividend reinvestment plans. Those were the days when, shortly after graduating from business school, I had begun immersing myself in Fooldom, learning a lot about investing. I still marvel that almost all I know about the stock market (at least all the practical knowledge I have) has been learned here within these virtual walls, and not at the ivy-covered institutions I've attended.
Ironically, about a decade before I learned about Drips, I had actually enrolled in one! All those years . . . I was dripping and never knew it.
I'd like to use my own example for this report, but I no longer own the shares in question and their story is therefore not the most instructive. I sold them to help pay for my MBA (ah, further irony!). So let me instead use my sister as my example. For after all, it was she who prompted me to make the investment, and she did so at the same time.
It was early 1988. I was teaching high school in Portland, Maine. My sister, recently out of college, was working at the J.P. Morgan (NYSE: JPM) bank in New York City. The stock market had crashed a few months earlier. Many stocks had not yet begun their recovery, or at least had not gotten very far. General Electric (NYSE: GE) stock, for example, was still trading about 30% lower than before the crash. The stock of J.P. Morgan, my sister's employer, had dropped from the mid-$40s to $27 during the crash, and was now in the low $30s.
At this point in our young lives, we really weren't investors. We knew that dad had some stocks, but he wasn't that interested in them, and neither were we. None of us had ever learned much about the stock market in school. Nevertheless, perhaps all the media attention to the "Crash of '87" had piqued my sister's interest.
One day she announced that she was buying some shares of J.P. Morgan, adding that perhaps I might want to do so, as well. I asked her now what her reasoning had been and she explained that working there, she observed that it was a conservative, careful place. She noticed that many employees, clerical and executive alike, were suddenly buying shares. Longtime employees exhibiting such confidence in the company was encouraging. She didn't get the impression that management was panicking or taking any reckless chances. True, the stock had crashed, but nothing had changed within the business. She couldn't imagine the company not growing or making money. In short, she saw little downside and considerable promise.
Around March of 1988, I bought 100 shares and she bought 200. I realize only now that we didn't buy these shares the traditional way. We never opened brokerage accounts. Instead, we bought directly through the company (presumably via a Drip available to employees, or to any investor).
We must have checked the box on the form that said, in effect, "Sure reinvest my dividends. Whatever." (I bet the "whatever" wasn't there on the form, but I'm pretty sure it was in our minds. We had no idea of the power of that check mark of what it would do.)
So here we are, a little more than 11 years later. I sold my shares long ago. But my sister still has hers. In fact, she has many more than her original shares. Let's review some of the facts.
In March, 1988 she bought 200 shares at about $35 each. Total cost:$7,000. (She was living with mom and dad then, so much of her take-home pay went into this investment.)
As of June 1999, she had about 310 shares. Total value: about $43,400.
Note that she never sent any more money to the plan. The 110 extra shares were all bought with her reinvested dividends. Let's break down the current value of her holdings:
Initial 200 shares are now worth: c. $28,000 Extra 110 shares are now worth: c. $15,400
If she hadn't checked the "reinvest my dividends" box, she would still be looking at $28,000 and a healthy return a four-bagger. (Annualized, that's about 13.4% per year.) But since she did, she's looking at more than a six-bagger, with an average annual return of 18%. What a difference that little box made! It's paid her more than twice her initial investment already, in just 11 years.
Here's some more powerful food for thought. As you probably know, companies generally increase their dividends every now and then, to keep pace with increases in earnings. Morgan was no exception. What was probably an annual dividend of about $1.75 per share when my sister bought in is now $3.96. If anyone buys shares of Morgan today, they'll enjoy an initial yield of about 2.8%.
But look at my sister's yield. Since she owns 310 shares, she's being paid about $300 per quarter, or a whopping $1,200 per year. When compared with her initial $7,000 investment, that represents an effective dividend yield of 17%. (Yowza!)
If the amount of the dividend is growing at about 7% per year, in 11 more years, it'll be roughly $8.00 per share. For my sister's 310 shares, that would represent an effective 35% yield on her initial investment. Of course, she'll have many more than 310 shares by then (thanks to reinvested dividends) perhaps somewhere in the neighborhood of 480. If so, then her effective yield will be an eye-popping 55%.
We're seriously into the land of what-if now, but let's stay just a little longer. If shares of J.P. Morgan quadruple in price once more in the next 11 years, they'll be trading around $560 each. With 480 shares, my sister's $7,000 investment will have grown to a quarter-million dollars in 22 years. Not bad! That's nearly an 18% annual return, though. If we project forward 22 years a more conservative 15% annual return, she'll have $150,000. Still, quite impressive.
I don't know about you, but several lessons jump out at me from this story:
(And hey if you think any of your friends might learn some useful lessons from this article, click on "e-mail this to a friend" at the top-right corner of this page.)