Continued from our June Newsletter...

Dividend stocks are all the rage right now.  Dismal bond yields push income-seeking investors into higher yield stocks, making dividend payers a fruitful asset class.  Many of these investors look primarily at the yield, and perhaps for those trying to maximize current income, that may be a place to start.  But dividend-payers have a role for the younger investor who may not be seeking current income, but actually seeking capital growth.  Dividend payers are not just for widows and orphans! The secret for growth-oriented investors is in dividend growth, not just dividend yield. A company that can regularly increase its earnings, can regularly increase its dividend. An increasing dividend, re-invested into more shares, brings the magic of compounding to a whole new level. 

Imagine a company that has been able to increase its dividend regularly for a number of years.  Let’s say this company has increased its dividend by an average of 10.8% per year for the last 20 years.  Twenty years ago this company paid you 40 cents per share as an annual dividend, and now pays $3.16 per share.   Twenty years ago, the adjusted share price for this company was about $8.00.  An investment of $24,000 would have bought you 3,000 shares and you would have been receiving annual dividends of about $1,200 for a yield of 5%.   Pretty decent return for an investment.  But 20 years later, those same 3000 shares are receiving dividends of $9,480 for a return of 39.5% on your original $24,000 investment.  Where in the world could you find an investment that yields you almost 40% per year?  Increasing dividends are a magical way to grow the return on your investment.  Of course, if you look at this company today, you don’t see a dividend yield of 39%.  The share price has climbed to $72.98 so the dividend yield you will see on this stock is 4.3%.  The yield is lower now than it was in 1992.  But at $72.98/share, this means that your original investment of $24,000 for 3,000 shares would now be worth over $219,000.   An increasing dividend usually results in an increasing share price, so not only do you make an increasing return on your investment because of growing dividends, you usually realize a consequent increase in the value of your capital.  Dividends increased at an average annual rate of 10.8%, and the share value increased at an average annual rate of 11.7%. 

DIVIDEND PAYING COMPANY EXAMPLES

The capital gain alone represents a great return, but the investment has also provided significant increases in income.  At first, the quarterly dividend cheque was only $300, but it has since grown to $2,370 per quarter.  Over the twenty years these shares provided income of $81,480, over three times the original investment.  But what if you were a younger investor, who didn’t need the income at the time?  What if you had reinvested those dividends over the past 20 years to buy more shares?  If you had taken the $300 dividend cheque from the end of September 1992 and bought more shares at the $8 price, you would have bought an additional 37.5 shares.  Your next dividend cheque would not have been $300, but would have grown to $303.75.   In December 1992, at a share price of $8.13, your dividend cheque would have bought 37.3616 shares and your March 1993 dividend cheque would have grown to $307.49. 

Now I realize that these changes do not seem material, and a $7 increase on an investment of $24,000 is not significant.  It is crucial to remember, compounding always starts off slowly.  In fact, this company did not start increasing dividends for another 3 years after September 1992, but despite that, after only five years of dividends being reinvested, you would have owned not 3000 shares, but 3714 shares.  Your quarterly dividend at the end of 1997 would have been $557.14 and you would have bought an additional 23.6 shares (because the share price had risen to $23.60.  In those first 5 years the dividends only rose by 50%, or 8.4% per year, yet your dividend cheque rose not by 50%, but by 85.7% because you owned 25% more shares. 

If you had continued this for twenty years, using the dividends as they arrived to buy more shares at the current market price, you would have re-invested a total, not of $81,480 that the income-seeking investor took, but $135,211!  Your June 2012 dividend cheque would be more than double that of the income-seeker at $4,956, which represents an annual yield of 82.6% on your initial investment.  What’s more, your original $24,000, plus the $135,000 of reinvested dividends, would represent 6,337 shares worth just over $500,000!  Reinvesting increasing dividends turbo-charges compounding.
This is the true story of the return potential from a seemingly boring stock (National Bank of Canada).  There were times during this 20 year period of solid average returns that an investor’s confidence could have been badly shaken.  In 2008, the year of the crash, this reinvested portfolio fell in value from a peak in December 2006 of $327,000 down to $171,600 in December 2008.  Looking at this from the view of the original $24,000 it is not disastrous, but seeing a 48% drop in the market value of your wealth can be very disturbing. Note that the dividend stream was still over $3,300 per quarter so that should have provided some comfort and you still owned 5400 shares of the bank.  No shares disappeared, but the value quoted by the market plummeted. 

Also crucial to note is that, with the dividend payment of $3,300 that quarter, because of the extraordinarily low price for the stock, you would have bought 106.5 shares, almost double the number of shares you were buying with previous (and subsequent) dividend cheques.  If you can stomach the 48% decline in value, low share prices are a great opportunity to boost the number of shares in your portfolio and your dividend potential.  This illustration is based on a twenty-year period starting in 1992 – shorter time periods and different starting dates yield different results, but the principle is sound.  For investors who started this process in 2007, they would have shown losses until September of 2009.  National Bank’s dividend was frozen for almost three years.  The headlines were highlighting threats to our banking system.  National Bank itself was involved in the Asset-Backed Commercial Paper (ABCP) debacle.  An investment of $24,000, would have bought about 365 shares, and with dividend reinvestment that would have grown to over 460 shares worth about $37,000 today. 

Note that the data for this analysis was obtained from the National Bank website, and that no allowance for fees or commissions has been included.  These would have diminished returns somewhat and slow (but not eliminate) the compounding effect.