LONDON -- Some of the biggest companies in the FTSE 100 (UKX) run schemes where investors can take dividends in the form of new shares instead of cash. This is known as a Dividend Reinvestment Plan (DRIP), or 'scrip' dividends.
If the company in question pays a large and increasing dividend, such reinvestment can quickly compound the size of your shareholding higher.
Using dividend data on HSBC (LSE:HSBA), you can see how the income produced by this titan bank has made dedicated shareholders richer.
|Shares Owned||Dividend Year||Dividend per Share (p)||Shares Purchased by DRIP Scheme||New Holding|
My figures are based on someone who owned 1,000 HSBC shares 10 years ago. Here is how dividend reinvestment has rewarded the company's investors.
Just over 10 years ago, shares in HSBC were 807 pence each. If an investor at the time bought 1,000 shares and kept reinvesting the dividends, they would today own 1,769 shares in the bank. Using today's share price, an initial outlay of 8,070 pounds would now be worth 11,375 pounds.
With $0.44 of dividends expected for 2012, that initial 8,070-pound investment is expected to yield 477 pounds in dividends this year.
The HSBC story demonstrates what can happen to a long-term DRIP investment when the dividend is cut. HSBC cut its payout in 2008 and again in 2009. The result was that the 2010 payout was less than half of the 2006 figure. Although HSBC fared better than most other banks in the financial crisis, returns for long-term investors were badly damaged.
There are some grounds for optimism. On a forward price-to-earnings ratio if 11.5, HSBC is currently undervalued compared with the average FTSE 100 share. Although the dividend was cut during the financial crisis, the resilience that HSBC has since demonstrated makes me think a much higher rating is deserved. After all, if HSBC was able to trade profitably throughout the credit crunch, what would it take to force the bank into reporting a loss?
HSBC is forecast to report a small decline in profits for 2012. This is expected to be followed by a 14.3% rise in 2013. The dividend is forecast to rise for two successive years. An increase of 5.2% is expected for 2012, followed by a 10.1% increase in 2013.
I believe the market will begin rerating bank shares as they put the crisis behind them. If I am correct, then HSBC looks ripe for an upgrade.
If you are interested in harnessing the power of income shares, then check out what Neil Woodford has been buying. This man has spent decades delivering huge returns to his investors by carefully selecting top income shares. Learn from one of the best in the business here with the free Motley Fool report "8 Shares Held by Britain's Super Investor". To get the report delivered to your inbox immediately, click here.
David does not own shares in HSBC. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.