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The Extraordinary Power of Dividends

What you see is often so much less than what you get.

Doug Short, who writes the finance blog, published this chart last week, showing the Dow in nominal terms next to its real value, adjusted for inflation:

Source:, reproduced with permission.

If you care about wealth, this picture should stop you in your tracks. Adjusted for inflation starting in 1895, the real value of the Dow is worth around one-twentieth its current value. Using a timeframe you can get your head around, the Dow has gained 7.4% annually since 1950, but it's only about half that -- 3.3% -- once inflation is factored in. That's simply incredible.

And yet when we talk about stocks over the long run, it's almost always the nominal price we're concerned with.


Because most people don't appreciate inflation's importance. Because the numbers are easy to find. Because journalists can't use calculators. I don't know. For whatever reason, the metric most used for measuring stocks over the long haul is defective. Horribly defective.

This bugged me. But then I thought about this more and realized there's another, even more important, variable the masses leave out when looking at stocks over the long term: dividends.

I'm going to switch indices from the Dow to the S&P 500, because there's infinitely more historical data for the latter. Anyway, here's what I wanted to find out: Adjusted for inflation and assuming all dividends are reinvested, what is the S&P 500's real, real, value today? I used figures from Yale professor Robert Shiller's database and found out:  

  • Current S&P 500 price: 1,319
  • S&P 500 in real terms, based on 1871 prices: 74.35
  • S&P 500 in real terms with dividends reinvested: 38,531
  • The power of dividends: Priceless.  

Here's another way to look at it:

Sources: Robert Shiller, author's calculations.

Reinvested dividends not only eliminated the eroding effects of inflation but lapped them many times over.

Now, the differences between the chart's three metrics are huge because we're using such a ridiculous time frame -- 140 years. Shorten that up a little bit, and the results aren't quite as impressive in more recent years, since companies having been paying out a lower percentage of earnings as dividends. Using 1990 as a base year, the S&P's real value is 759, versus 1,182 when reinvested dividends are added in. At any rate, the impact of reinvested dividends is enormous over time.

This is nothing new. It's not a novel discovery. Sorry if that disappoints you. Yet the compounding magic of dividends is overlooked so often by so many otherwise intelligent investors. Some specific examples of dividend's impact are nothing short of astounding. Since the late '60s, Pfizer (NYSE: PFE  ) has increased 4,200%. Add in reinvested dividends, and it jumps to 13,200%. Johnson & Johnson (NYSE: JNJ  ) is 9,700%, or 21,400% adjusted for dividends. For Coca-Cola (NYSE: KO  ) it's 4,700% versus 14,300%. Altria (NYSE: MO  ) is the probably the best example: Its shares have increased 10,800% since the late '60s, or 255,000% adjusted for dividends. Dividends aren't token gifts. They're often the backbone of shareholder returns.

Fortunately, I think our ignorance of dividends is starting to change. In the past, inventors' focus was mostly on capital appreciation. The point of owning stocks was to buy low and sell high. After being humbled for ten years in a market that's gone nowhere, that's starting to change. Some investors have become so disenchanted with stocks that expectations of capital appreciation are flat. Many investors are counting on dividends almost entirely to produce returns. You can see this in the cult-like reaction to articles about dividend stocks all over the web -- an attitude that wasn't present in years past. At any rate, it isn't necessarily a bad thing. As John D. Rockefeller once said, "Do you know the only thing that gives me pleasure? It's to see my dividends coming in." He understood the power of dividends. Many others are starting to as well.

Interested in these dividend stocks? Add them My Watchlist. Just click here

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel owns shares of Altria and Johnson & Johnson. Johnson & Johnson, Coca-Cola, and Pfizer are Motley Fool Inside Value picks. Johnson & Johnson and Coca-Cola are Motley Fool Income Investor recommendations. Motley Fool Options has recommended a diagonal call position on Johnson & Johnson. The Fool owns shares of Altria Group, Coca-Cola, and Johnson & Johnson. Motley Fool Alpha owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (19) | Recommend This Article (56)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 08, 2011, at 4:07 PM, pryan37bb wrote:

    I'm confused, I thought the DJIA was already inherently inflation-adjusted, since its underlying companies can raise prices in response to inflation, meaning that their cash flows are in real, not nominal, terms.

  • Report this Comment On March 08, 2011, at 4:55 PM, mdtopper wrote:

    I am also confused. But on a slightly different point.

    Dividends are a payment i receive. Whether I invest them in the company that paid them or not, they don't change the value of the initial investment.

    I think Including reinvested dividends in the computation simply exaggerates the return attributable to the initial investment. Invest $1,000. If you put dividends over 5 years in CD and Investment grows to $2,000 then return is 100% over 5 years or approximately 20%.

    If instead you reinvest dividends in stock total value at end of 5 years will be more than $2,000 and return IF CALCULATED ON ORIGINAL INVESTMENT would be higher than 100%. But that is simply illusory.

  • Report this Comment On March 08, 2011, at 6:28 PM, Case58 wrote:

    Something that has always confused me about these comparisons is the failure to take into account the taxability of dividends. Dividends historically have been taxed at ordinary income, though 15% right now. Assume an overall rate of 20%. There's a dividend of $10, which is reinvested. But the recipient has to pay $2 in tax on that dividend. So, really, the recipient hasn't reinvested $10. Rather, he or she has reinvested $8 and contributed $2 in new money, which means treating the historical returns as all due to the reinvestment seems false to me.

    Is this analysis accurate?

  • Report this Comment On March 08, 2011, at 7:03 PM, xetn wrote:

    "Inflation adjusted" is also a moving target because the calculation keeps getting changed to suit the administration du jure. This is the fight that shadowstats tries to correct.

    But I am very happy that TMF and in particular Morgan has shined a bright light on this subject.


  • Report this Comment On March 08, 2011, at 9:14 PM, ershler wrote:

    Including dividends present a much better picture of your actual returns than not including them. If mtopper and I invest in two different stocks that appreciate the same over 10 years but my stock pays a dividend I will have more money than mtopper will. If I choose to reinvest the dividends they will be worth more than the actual value of the dividend payments if the stock appreciated or less if it depreciated but I will always have more than mtopper.

    I would agree with Case58 that not including the effect of taxes artificially increases the returns and highlights a major tax advantage of keeping dividend paying companies in a 401K or IRA account (Regular or Roth).

  • Report this Comment On March 08, 2011, at 9:21 PM, TimothyVR wrote:

    Great article. Dividend payers are the core of my portfolio. I am just sorry that I waited until my mid-40s before I realized what I was missing. An article here on the Fool site gave me the wake-up call I needed.

    Now I watch KO, P&G, J&J and a few others accumulate reinvested dividends while I add more to the core.

    Hopefully others will not wait like I did. I'm just glad I didn't wait even longer.

  • Report this Comment On March 08, 2011, at 10:36 PM, Alfredodos wrote:

    Dividends can be overrated. I've owned one of the stocks discussed in this article since 1999 and the share price has plummeted. Dividends have helped buy additional shares yes but this was still a lousy investment. What good are dividends when the stock value sinks? On the contrary if you're lucky enough to buy a stock that the price rises while receiving a great dividend than you've done well. Dividend alone is hardly a reason to invest.

  • Report this Comment On March 09, 2011, at 12:02 AM, LazyOldMan wrote:

    Now pay attention boys and girls... it is all about compounding.... Those dividends you reinvest in the stock (DRIP) get you more shares which get you more dividends, and so on... and so on. That is why dividends shouldn't be ignored.

  • Report this Comment On March 09, 2011, at 8:35 AM, Stocklovr wrote:

    Think of dividend re-investing as simply as this: I purchased a stock many years ago. The stock paid a dividend which I allowed to reinvest in more shares each time it paid. The majic of compounding occurs. Now I have a lot more shares than I initially bought. Simple enough.

    At one point down the road, the stock has paid out more in dividends than my initial investment. 100% of my initial investment has been returned to me via., dividends so it has cost me nothing for the stock. In addition, each and every dividend check is now paying more than it cost me to purchase the stock!

    This, my friends, is the power of dividend investing! I didn't even mention the excellerated compounding you get when companies give you a raise every year when they increase the dividend.

    The main caveat is that this is not a get rich quick method. It is the slow boat to wealth but it definitely works.

  • Report this Comment On March 09, 2011, at 10:27 AM, PEStudent wrote:

    case58 - excellent point. I have stocks in DRIPs and have all dividends reinvested. But they increase my income tax so I'm effectively investing an additional, as you say, about 20% of the dividends each year.

    Even so, the effect of dividends is surely significant, but the other problem with this study is that none of us was investing in 1871 when dividends represented more of the annual gain than now and many of us began investing at a time when a 1.5% dividend was big.

    I currently have about half my stocks in DRIPs with 3% to 6% yields and expect the dividends will provide roughly 1/3 to 1/2 the annual gain. So I wouldn't call the dividends "priceless" today. But they're certainly important.

  • Report this Comment On March 09, 2011, at 10:45 AM, slpmn wrote:

    Seems like most of us agree that dividends can be a critical component of long term shareholder returns. The question is, why don't more companies pay them, especially when you consider how corporate cash levels are extremely high right now? Follow-up question - what is better, stock buybacks or dividends? Both are uses for excess cash, and both supposedly benefit shareholders, but seems like in the last 20 years, its buybacks that have become more common.

  • Report this Comment On March 09, 2011, at 1:25 PM, bigdividends wrote:

    Alfredodos makes an interesting point. He invested in a dividend stock where the price has drop significantly in the last 12 years (I am assuming it is PFE). Psychologically, we think of winners as stocks constantly appreciating in price. With dividend stocks (especially if holding for a very, very long term and reinvesting), you almost want the opposite. You like major dips in the price because you can accumulate more shares which can increase the number of shares dramatically.

    As long as the company is consistently raising dividends and has a pretty good track record doing so, dips within a stock actually work to your advantage.

    Now if they start cutting or reducing their dividend, time to reevaluate.

  • Report this Comment On March 11, 2011, at 1:04 PM, FREEHIKER wrote:

    In the late eighties, the company I work for gave us 11 shares of company stock, worth about $440.

    I didn't know anything about the stock market,but every quarter, I received a dividend check for a few dollars. Then, in 1994 along with the check, I received a form to reinvest the dividend. I sent the form back. If I had not, I would have received a few dollars in dividends and would have through splits, 44 shares worth about $700. with the reinvestment and stock splits and no more out of pocket,, I have 145 shares worth a little over $2300.

  • Report this Comment On March 11, 2011, at 5:27 PM, investolator wrote:

    I had thought that there was more historical information about the Dow than the S&P 500. The book with all the historical information about the Dow is "The Dow Jones Averages 1885-1995"

    edited by Phyllis Pierce. This book has the closing average for all four basic Dow Jones Averages including the Industrials, Transportation, and Utility since the averages were started in the 19th Century. And this book tells all the changes that were made to the Dow averages between 1885 and 1995.

    Please tell me the title of any book that gives the daily S&P 500 averages for a number of years.

    The above book also gives the daily volume and the basic Dow bond average.

  • Report this Comment On March 11, 2011, at 5:36 PM, cmfhousel wrote:

    "Please tell me the title of any book that gives the daily S&P 500 averages for a number of years"

    It's not a book, but Yale's Robert Shiller keeps a database of the S&P going back to 1871. Furthermore, a book for this kinda of stuff wouldn't be much use; the data needs to be in a spreadsheet if you want to do anything with it.

  • Report this Comment On March 11, 2011, at 5:37 PM, JayBob100 wrote:

    True regarding taxes on dividends; start early with a Roth IRA and don't worry about the taxes!

    Start early, enjoy compounding! Mix it up a bit with dividend stocks and growth stocks if you like, just pay attention to the growth stocks.... Been trying to get my kids to catch on to this Foolish idea.


  • Report this Comment On March 13, 2011, at 1:54 AM, trenton1ryan wrote:

    < Dividends have helped buy additional shares yes but this was still a lousy investment. What good are dividends when the stock value sinks?>

    Because if you're really serious about dividends, you're thinking about building up your income stream from these divvies-not about the share price (unless it plummets so much that they cut they divvie. Then it's time to say goodbye.).

    If you want dividends to make maximum impact, you want to concentrate on reinvesting them (buying MORE shares), and buying more shares with new money. Thinking ahead-as another poster eloquently explained, the amount of these dividends will be quite large, particularly relative to your original investment. Not only will you have made your original investment back, but perhaps you can retirement on some (or all) of you income stream from these dividends that you've been reinvesting.

  • Report this Comment On March 13, 2011, at 3:19 PM, crca99 wrote:

    Suddenly I'm the one who needs a follow-up article. Given these two situations, are taxes paid annually in both? 1) Cash dividends go into the brokerage account, are reinvested into something else, but never leave the account. This triggers annual tax. 2) Dividends enter brokerage account as reinvested shares instead of cash. Are there any taxes on that, or is tax due only at sale?

  • Report this Comment On March 15, 2011, at 7:29 AM, DrRonPaul4Prez wrote:

    I'm going to say an incredible thing: Don't think about inflation when it comes to investing! The reason is simple: you can't control it. Invest in whatever gives you the best return, which is the stock market. The best returns come from stocks with both dividends and capital don't buy an over-valued stock just because it pays a dividend. Be selective and wise. Good luck.

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