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

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


Source: Dshort.com, 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.

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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.