Last week, we learned how the dispersal of dividends by a company may not be in the best long-term interests of the company because it can lead to lower shareholder value than may otherwise be possible. However, any theory needs to be strengthened by the support of numbers.

To find out how companies are affected by dividends, I decided to look at large companies — those with a market capitalization of $10 billion or greater. These are the companies that we normally look at when considering a Drip.

I initially separated these companies into two groups: companies that offered no dividends, and companies that offered a dividend yield of 2.25% or greater. I selected this value because it gave me approximately the same number of companies (73) as those that didn't offer a dividend (69).

Using Hoovers' excellent StockScreener tool, I looked at the five-year total compound return of each company. This is the five-year period price change plus dividends paid during the past five years, divided by the stock's price at the beginning of the period. The number is expressed as a percentage.

The companies in the dividend group offered an average dividend yield of about 3.5%. This group, with dividends reinvested over the past five years, offered a 94% return. This is a respectable number.

However, I wasn't prepared for the results from the other group. I found that the no-dividend group, over the past five years, has yielded 1,374%. This is nearly 15 times the amount of the high-dividend group.

I then decided to see how the remaining 144 "moderate-dividend" companies stacked up. Over the past five years this group returned 260%. Better than the high dividend companies, but not as good as the no-dividend companies.

I finally decided to see if there was a correlation between the amount of a company's dividend yield and the five-year total compound return. I found that after the dividend yield passes 1%, the compound return really begins to suffer. Below is a chart showing this.

Dividend Yield   5 Yr Total Return
0.00 %            1374.73%
0.01 % to 0.20%   466.91%
0.03 % to 0.40%   329.62%
0.05 % to 0.60%   248.59%
0.07 % to 0.80%   303.32%
0.09 % to 1.00%   336.13%
0.11 % to 1.20%   166.02%
0.13 % to 1.40%   166.16%
0.15 % to 1.60%   170.50%
0.17 % to 1.80%   173.78%
0.19 % to 2.00%   133.97%
0.21 % to 2.20%   143.67%
0.23 % to 2.40%   144.40%
0.25 % to 2.60%   113.84%
0.27 % to 2.80%    79.87%
0.29 % to 3.00%   105.56%
So, the final question is whether or not we should shun companies that offer dividends. The certain answer is that we should not. We should consider all companies that meet our criteria, but keep in mind that the dividend is not the silver bullet of surety we might have originally thought.

Editor's thought: Jeff Fischer (TMF Jeff) here. I'm going to add a thought to George's excellent column. First, long-term studies do show how reinvested dividends create substantial extra wealth. The S&P 500 rose less than 8% annually the past 70 years without reinvested dividends, but it rose 11% annually with dividends reinvested. Invest $10,000 over this time period and reinvested dividends will lead to a return of hundreds of thousands in extra dollars.

That said, George's study pitted companies without any dividends to those paying dividends. Presumably, the companies that are not paying dividends are usually younger, technology-focused firms like Microsoft (Nasdaq: MSFT) and Cisco Systems (Nasdaq: CSCO), and they are growing more quickly than older companies paying dividends. Plus, these newer companies have enjoyed great popularity with investors in the past decade, while older, dividend-paying companies have taken the back seat. That almost certainly won't always be the case.

My personal conclusion and lesson learned from George's column is this: Every Drip portfolio should have a few companies in it that don't pay dividends (or pay very slight dividends) because the money earned is mainly reinvested back into the business instead. For us, so far, our holding like this is Intel (Nasdaq: INTC), and look how well it has done. But a Drip investor shouldn't forsake dividends, either, as George concurs, because dividends are an integral part of Drip investing that often lend to better and more consistent long-term returns.

Your Turn:
What do you think about investing in companies that pay dividends as opposed to those that don't? Are your reinvested dividends serving you as well as they should?

Suggested Links:
Our Preference for Dividends, Drip Port, 1/7/00
Dividends Do Matter, Drip Port, 8/25/98