by Investing Daily, Investing Daily
— this post authored by Nick Lanyi
Investing Daily Article of the Week
For most people, owning dividend-paying stocks is like going to the dentist: you do it because you need to, not because it’s fun.
But dividend-paying stocks are now the only decent option for income investors in this era of low-yielding bonds and no-yielding money markets. In the yield desert we live in, a 4% dividend yield is manna from heaven.
But behind the boring façade, dividend stocks are actually kind of sexy. And they can make you rich.
Not to brag, but I will: Investing Daily has top newsletters for dividend investors. Our Utility Forecaster is routinely ranked among the top newsletters by Hulbert Financial Digest. And we also have powerful portfolios of top dividend stocks in Canadian Edge and Personal Finance as well. In fact, Personal Finance just added one with a yield that tops 7%.
Now I know you’ve heard about the benefits of dividend reinvestment … the power of compounding and all of that. I won’t waste your time on the theory.
But when was the last time you sat down and did the math? Do you truly understand how powerful reinvested dividends can be?
I know, you hate math. So I’ll do it for you.
The Math
Let’s assume we buy 200 shares of a $50 stock for $10,000. The stock yields 4%, or $2 per share, every year. We reinvest all dividends into purchases of new shares. Let’s further assume that the share price goes up 5% a year and the company raises its dividend 5% a year – reasonable assumptions for the high-quality stock with solid cash flows that we recommend.
In fact, share price appreciation of 5% per year is a conservative assumption given the historical performance of our portfolios. (For the purpose of this example, we’ll assume we reinvest dividends at the end of each year, and we won’t take commissions or taxes into account.)
Year | Dividend per share | Dividend payment | # of shares owned | Share price | Total value |
Initial purchase | 200 | $50.00 | $10,000.00 | ||
End of Year 1 | $2.00 | $400.00 | 207.62 | $52.50 | $10,900.05 |
End of Year 2 | $2.10 | $436.00 | 215.53 | $55.13 | $11,882.17 |
End of Year 3 | $2.32 | $500.03 | 224.17 | $57.88 | $12,974.96 |
End of Year 4 | $2.43 | $544.73 | 232.83 | $60.78 | $14,151.41 |
End of Year 5 | $2.55 | $593.72 | 242.13 | $63.81 | $15,450.32 |
End of Year 6 | $2.68 | $648.91 | 251.82 | $67.00 | $16,871.94 |
End of Year 7 | $2.81 | $707.61 | 261.92 | $70.36 | $18,428.69 |
End of Year 8 | $2.95 | $772.66 | 272.38 | $73.87 | $20,120.71 |
End of Year 9 | $3.10 | $844.38 | 283.27 | $77.57 | $21,973.25 |
End of Year 10 | $3.26 | $923.46 | 294.61 | $81.44 | $23,993.04 |
Two observations:
Your $10,000 investment turned into $23,993.04 after 10 years. That’s a total return of 139%, or an annualized return of 9.1%. That’s well above average for the stock market over time.
The stock’s dividend in Year 10, $3.26 a share, represents a yield of 6.5% on your original share price. In effect, you’ve turned a solid 4% yielder into a high-yielding stock. In a few more years, you’ll be raking in a double-digit yield on your original investment.
As this shows, dividend-paying stocks can form the foundation of a wealth-building portfolio.
Most of us also invest in growth stocks that can provide a lot more capital appreciation – including some more aggressive picks for explosive growth. But when you have a chance to pick up shares of solid-yielding blue chips like Boeing (NYSE: BA), Duke Power (NYSE: DUK), Pfizer (NYSE: PFE) and Verizon Communications (NYSE: VZ), do it.
Even better, get one or two of our newsletters with powerful dividend portfolios, and be introduced to a slew of perpetual-motion, dividend machines that don’t often make the headlines.
