ALEXANDRIA, VA (Oct. 15, 1998) -- Even though concepts such as "investing for the long-term" and "and reinvesting dividends" are bandied about in this column quite frequently, it is easy for investing newcomers (such as myself) to lose track of what these ideas really mean. Sometimes, a concrete example is needed to make sure that a point is driven home square and true. Words are just words, after all. Occasionally, all of the preaching in the world cannot convert the masses to your way of thinking.
Sometimes, you must learn the hard lessons from another's misfortune, if not your own.
On Monday, I got somewhat carried away describing what the economic concept of opportunity cost means to investors. Like good college economics students, I assume most readers slept through the lecture in the hopes that the crazed Professor would give a more relevant (and interesting) example at the end of class to illustrate just what in the heck he has been trying to say. Well, class, enough with the theory -- here's your concrete example of opportunity cost.
A good friend of mine, who will go nameless so I can selfishly guard the fact that she cooks the best apple pies in the world, received 101 shares of General Motors (NYSE: GM) stock in 1974 the old fashioned way -- she inherited them. Unfortunately for her, the dividends from those shares were never reinvested via GM's DRP. Fortunately for us, she has never sold any of her gifted shares, providing us with a perfectly-preserved example of the opportunity cost of not DRP-ping those shares.
The total return data for her GM shares that I obtained courtesy of Bloomberg only goes back to 1980, so this misses six years. But the results are still illuminating. If the dividends from my nameless friend's 101 GM shares had been placed in the company's DRP in 1980, the reinvested dividends would have purchased an additional 285 GM shares over the past 17 years. That means instead of having the 202 GM shares she now has (thanks to a two-for-one stock split in 1989), she could have had 487 -- or more than twice as many, with virtually no work! Here, the opportunity cost of not joining the DRP in 1980 is 285 GM shares.
But here's the scary part.
On Dec. 31, 1980, GM's shares were at $42.52 per share. That means her 101 shares were worth $4,294.52 on that date, which was about a month before President Reagan took office.
Based on GM's price of about $60 per share at the end of 1997, her 202 split-adjusted shares had grown in value to $12,120 through pure share price appreciation alone, but without the benefit of reinvested dividends.
Had the dividends been reinvested since 1980, her original gift of 101 shares would have been worth... drumroll please... $25,313.
So, my apple pie-baking friend lost out on a $13,193 gain, which is the opportunity cost of her non-participation in GM's DRP over the past 17 years. And instead of the 12% average annual gain she would have received from her shares with reinvested dividends over that span (roughly matching the long-term average gain for stocks this century), her shares actually gained a little less than 6% per year on share price appreciation alone. (Note: for clarity's sake, our analysis doesn't include the shares of EDS (NYSE: EDS) or Rockwell (NYSE: ROK) which she has received over the years from various GM spin-offs.)
Fools still awake at this point are probably wondering what happened to all of those dividends that weren't reinvested in additional GM shares, which in her case totaled $6,357.95 over the past 17 years. That money was deposited into a savings account for her recently-completed college education by the custodians of her portfolio, which happened to be her parents. This is somewhat refreshing, as she at least derived a tangible long-term benefit from her dividends, which in this case took the form of a college diploma. However, with a such a long-term goal in mind, her parents would have been able to help her future education much more if they had only placed those dividend checks back into GM stock rather than in a plain vanilla savings account.
Oh well. If only her parents had known better. And that, by the way, is how investors can overcome opportunity cost in a nutshell: Always take the time to learn whether you will be better served in the long-run by making one distinct investment decision over another.
After all, once your time is spent, it cannot be refunded.
P.S. The Intel conference call summary is now on the Fool.