Livin' on Dividends
...how and why they matter so much
by Jeff Fischer ([email protected])
ALEXANDRIA, VA (August 25, 1998) --Two weeks ago, Phil Weiss wrote something in the middle of a Cash-King column that I knew should be called to attention here. In fact, Phil's statements merit being the focus of an entire column. Though we've discussed the importance of dividends numerous times, perhaps we haven't done so convincingly or succinctly enough. We'll try to do that today.
Phil recently wrote the following on the subject:
"The real power of dividends comes from owning a stock over a long period of time. Say that you purchase a Cash-King that currently has a dividend yield of 1.5%. If the dividend is increased by 12% per year, then it will double every six years. This means that in twelve years, the dividend return on the original investment will be 6%.... Better yet, if you go out another six years (for a total of eighteen), then the dividend yield on the original investment will be 12%. This is just a different way to look at the power of compounding.
"I've seen Rob [a C-K writer] state in the Cash-King folder that his goal is to be able to live off his dividends when he retires. Believe it or not, if you start investing in Cash-Kings early enough, this could happen -- quite likely, in fact. If you take my example out for a total of thirty years, then you'll end up with a 48% return on your original investment per year [in dividends alone]. With those kinds of dividends coming your way, there may be no reason to sell your Cash-King stocks [for] additional income."
Got that, fellow Fools?
The fact that years from now you could be earning a 48% annual return on your original investment through dividends alone -- steady, near certain income -- is astounding. It's also part of the reason why stocks outperform all else over the long-term, and why you need to invest for the long-term in order to truly benefit from owning leading, growing companies.
Consider some numbers.
Stock of the Coca-Cola Co. (NYSE: KO) has compounded 16% annually since 1919, but that's only if dividends were reinvested. The company came public at $40 per share. A single $40 share from 1919 is now worth over $5 million. But, without dividends being reinvested, your $40 share is now only worth $250,000 -- a $4.75 million difference. Over the seventy-nine year period, a $40 share has paid over $21,000 in dividends alone, which, reinvested, made all the difference. Not reinvested, a person simply received small checks every three months that were probably frittered away through the years -- blown on hula-hoops and drive-in movies.
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. A bond this isn't.
But let's consider our stocks.
Johnson & Johnson (NYSE: JNJ) has grown its dividend 16% annualized each of the past ten years. It now pays $1.00 per share in dividends. Assuming that JNJ can increase its dividend 11% annually for the next thirty years, the company would be paying a $23 annual dividend in the year 2028, giving us a 33% annual yield on our initial shares and the shares we're buying now. A $23 dividend might sound crazy, but after stock splits are considered it would be a more conventional number, and easier to grasp. (Meanwhile, the split-adjusted cost-basis of our initial JNJ shares might be in the low teens or even single digits in a few decades. How would you like to be your own child, inheriting your portfolio!)
Of course, there's no guarantee that JNJ's dividend payout will continue to grow -- or continue at all, some might argue. I believe that the dividend will do both, though -- continue and grow -- because it's institutionalized and the company, assuming momentum, is in a position to continue the practice.
Campbell Soup (NYSE: CPB) is our highest-yielding stock. It pays a 1.60% dividend yield, or $0.84 per share annually. Following our additional $200 investment in Campbell that we announced yesterday, we'll own about eight shares of the stock, granting us $6.72 in annual dividends. If we reinvest them with Campbell we'll pay a 5% fee, or thirty-three cents in the first year. Maybe we don't want to reinvest the dividend in Campbell stock and pay this constant 5% fee (up to $3). Our $420 investment in Campbell growing 11% annually becomes $3,650 in nineteen years, paying a $58 yearly dividend based on the current yield. A 5% fee on this amount is just about $3 -- the upper limit -- meaning that we'd be paying the maximum 5% fee on every reinvested dividend right up to the end. A 5% commission for nineteen years is far too high.
So, imagine if instead we enrolled in Coca-Cola's (NYSE: KO) dividend reinvestment plan. Critics complain that the stock currently only yields 0.70% -- indeed, that's a somewhat paltry amount. But, we could receive Campbell's dividend in cash for free and use it to buy more Coca-Cola for free as well. What this would mean is that for the first few years, we'd be receiving at least $1.44 annually in dividends with which to buy more Coca-Cola stock. (This number is obtained by adding Coke's $0.60 annual dividend and Campbell's $0.84 dividend.) At current prices, our first Coke shares would effectively yield at least 1.82% and for at least the first few years, and all of this payout would be reinvested in more Coke stock.
In fact, if we initially owned only a few shares (say two) of Coca-Cola and eight shares of Campbell Soup, we'd receive $6.72 in annual Campbell dividends and $1.20 in Coke dividends, or $7.92 total. On $160 worth of Coca-Cola shares, that's a giant 8% dividend yield to reinvest in more Coca-Cola. (Of course, our Campbell shares would effectively yield us nothing, but there'd be no fees, either.) Meanwhile, we'd wait for Campbell to remove its dividend reinvestment fee before reinvesting our Campbell dividend in its stock.
It's a thought.
I hope that this column and Phil's words help to reiterate the giant impact that dividends can have on an investors' lifelong success. If you'd like to discuss dividends, numbers and certain companies further, please visit the Drip Companies message board.
Fool on!
--Jeff Fischer
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The Drip Portfolio has been divided into 76.682 shares with an average purchase price of $23.474 per share.
The portfolio began with $500 on July 28, 1997, adds $100 on the 1st of every month, and the goal is to have $150,000 in stock by August of the year 2017.
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