What happens when dividend investing in a dividend stock that does not increase in price?
Not Common
Most all stock prices vary. In fact I never see any stock that does not have a fluctuating price. Some prices swing tremendously, some mildly.
Let’s Not Argue
For argument’s sake, let’s take a look at a theoretical stock with a stable price of $100.00 and with a static annual dividend of, say, 2%. (A 2% yield is slightly less than the current Dow Jones yield, and slightly more than the current S&P 500 yield.)
In the following theoretical example, if the stock price is a stable $100.00 and the yield is a stable 2%, then obviously the annual yield in dollars per share is $2.00. Since most companies pay quarterly, the income for each quarter is $0.50. No surprises there.
Let’s look at income over time with and without dividend reinvestment. (Let’s assume no dividend reinvestment fees.)
Without dividend reinvestment, for each share we receive $2.00 per year. The total amount of income is the number of years multiplied by $2.00 (or the number of quarters multiplied by $0.50.) So after ten years (40 quarters), we have received a total dividend income of $20.00 per share. If we have 100 shares, our total income is $2,000.00.
With dividend reinvestment, things are different. Skipping receiving the $20.00 dividends per year in cash, but rather reinvesting it, now means that after 10 years, we now own 122.079 shares, providing $60.74 in that quarter. If we add up all the dividend income we have reinvested, we see it is a total of $2,207.94.
It is also interesting to note that by this tenth year, we are adding to our share count 2.4 shares per year,
So we have produced more than $200 additional income for doing nothing, or nothing special. And if we subsequently need or want the income, all we need to do is turn off dividend reinvestment, and the $60.74 will come to us in cash each quarter, rather than the original $50.00 per quarter.
How to read this table. The first quarter, the dividend income is $50.00, which is calculated by multiplying the number of shares (100) times the price per share ($100.00) times the 2% yield (0.02) divided by four (each quarter is one-fourth the annual yield). At $100 per share, $50.00 then buys one half (0.5000) of a share, which increase the number of shares we own from 100.0000 to 100.5000.
The table shows that if we hold the stock with dividend reinvestment for a total of twenty years (80 quarters), our last quarter income would be $74.15, we would own a total of 149.03 shares. By this twentieth year, we are increasing our share count by 2.94 shares per year.
Practice vs. Theory
In the above theoretical example, as mentioned, the share price is a stable $100.00. In practice this would never happen. As mentioned, share prices vary, sometimes greatly. In addition, many companies increase their dividends over time. In addition, stock prices tend to reflect changes in the company’s business as well as the overall economy. So if the company’s business and prospects increase, so likely would the stock price. The stable price and dividend also do not take into account the effects of inflation. If the stock price and dividend remain perfectly stable, and inflation exists as usual, both the stock and the dividend are, in essence, losing value. So for all these reasons, and perhaps others, this example is, simply a theoretical one.
The purpose of this example is to show the benefits of “doing nothing” and reinvesting the dividend once a stock is purchased, assuming dividends continue. However, I would be the first to admit that the returns from the example above are nice but not stellar. This stock is acting almost more like a bond or a savings account. If inflation were zero, then it could acceptable, but that is not the world we live in. Since we cannot predict inflation, then giving another theoretical example would be fruitless. As stated, in the real world, stock price volatility, inflation, changes in business conditions, changes in dividends issued, all effect our returns.
It should be said that in a deflationary environment, having a steady income such as in the example stock would be precious. In the U.S., it is very rare to experience an ongoing deflationary environment. Of course history informs us that conditions during the Great Depression were deflationary. While not out of the realm of possibility, deflation for any extended amount of time in he U.S. would be extraordinary and therefore very unlikely.
Real World
Let’s look at what normally happens regarding a typical stock. I suspect we would have much better results. Here are some expectations: The stock price would fluctuate, such that when prices decline dividends would buy more shares than in the example. I probably would have increased my holding by buying additional shares. The business would grow, such that the stock price would also increase. Since the price would increase, then it is likely the dividend would also increase, so additional shares would be purchased from those increased dividends. I am reluctant to show any example, as timing is everything, and choices as to which company to buy are just about infinite. But suffice it is to say, and choosing one from a major company will likely show benefit over the longer term.
So then we would experience a much better outcome. An active stock for a growing business presents opportunities for gain. A stable price with a stable dividend will lose due to inflation.
What is your take on this? Let me know here.
The illustration of the Palace of Donn’Anna is by Jean-Baptiste Isabey and is from the 1823 book “Voyage en Italie” published. Courtesy Cleveland Museum of Art, and is in the public domain via the Creative Commons CC0 license.
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