Dividends Count

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There are two ways to profit from the stock market: capital gains and dividends. Some investors generally shrug off the few dollars they receive in dividends and focus on capital gains. However, over the course of decades, dividends play a relevant role in calculating the total return on investment. Let’s take a look at three examples.

Over the past 10 years, dividends doubled the annualized return for Microsoft (NASDAQ: MSFT), as you can see in the table below. Ten years ago, Microsoft traded at $21.87; that price rose to $29.77 as of the market close on Sept. 28, 2012, equating to a $7.90 per share gain or 3% per annum. During that time, Microsoft paid share owners $7.31 in dividends. Withdrawing the dividends and throwing them in a cookie jar would have increased annualized returns to more than 5% (229 basis points). Compound and reinvest those dividends on the market close of the day the dividend was paid, and the annualized return jumps another full percentage point (93 basis points).

<table> <tbody> <tr> <td colspan="3"> <p><strong>Annualized Microsoft Returns, 2002-2012</strong></p> </td> </tr> <tr> <td> <p><strong>Capital Gains Only</strong></p> </td> <td> <p><strong>Cumulative Dividends (Not Reinvested)*</strong></p> </td> <td> <p><strong>Dividends Reinvested**</strong></p> </td> </tr> <tr> <td> <p>3.13%</p> </td> <td> <p>5.42%</p> </td> <td> <p>6.35%</p> </td> </tr> </tbody> </table>

*Total dividends paid between Sept. 30, 2002-Sept. 28, 2012. 
**Assuming dividends were reinvested on the market close of day of payment.
Source: Microsoft investor relations.

Dividends boosted the total returns for Wal-Mart (NYSE: WMT). As shown in the table below, capital gains for Wal-Mart amounted to a little over 4% per annum, increasing from $49.24 to $73.80 per share over the 10-year period ending Sept. 28. That's a gain of $24.56 per share. Wal-Mart paid $9.02 per share in total dividends during this period, increasing its annualized return to more than 5% (229 basis points). Reinvesting dividends would have increased annualized returns 176 basis points over capital gains, to nearly 6%.

<table> <tbody> <tr> <td colspan="3"> <p><strong>Annualized Wal-Mart Returns 2002-2012</strong></p> </td> </tr> <tr> <td> <p><strong>Capital Gains Only</strong></p> </td> <td> <p><strong>Cumulative Dividends (Not Reinvested)*</strong></p> </td> <td> <p><strong>Dividends Reinvested**</strong></p> </td> </tr> <tr> <td> <p>4.13%</p> </td> <td> <p>5.34%</p> </td> <td> <p>5.89%</p> </td> </tr> </tbody> </table>

*Total dividends paid between Sept. 30, 2002-Sept. 28, 2012
**Assuming dividends were reinvested on the market close of day of payment.
Source: Wal-Mart investor relations

McDonald’s (NYSE: MCD), the highest performer in the group discussed here today, expanded its returns by the highest amount. The share price increased more than 15% per annum over the past 10 years -- from $17.66 in 2002 to $91.75 as of Sept. 28, with a total capital gain of $74.09. Pocketing the company's $14.92 per share in dividends over the past 10 years increased McDonald’s annualized return by 214 basis points to 17.5%. Reinvestment of dividends would offer 351 basis points over capital gains alone, and 143 basis points over pocketing dividends, with returns approaching 19%.

<table> <tbody> <tr> <td colspan="3"> <p><strong>Annualized McDonald’s Returns 2002-2012</strong></p> </td> </tr> <tr> <td> <p><strong>Capital Gains Only</strong></p> </td> <td> <p><strong>Cumulative Dividends (Not Reinvested)*</strong></p> </td> <td> <p><strong>Dividends Reinvested**</strong></p> </td> </tr> <tr> <td> <p>15.42%</p> </td> <td> <p>17.56%</p> </td> <td> <p>18.99%</p> </td> </tr> </tbody> </table>

*Total dividends paid between Sept. 30, 2002-Sept. 28, 2012. 
**Assuming dividends were reinvested on the market close of day of payment; does not include spinoffs.
Source: McDonald's investor relations.

The power of compounding dividends expands over 20 and 30 years. Take the McDonald's example, and assume that dividends and stock price will increase at the same rate. In that scenario, a $1,000 investment morphs into $25,421 over 20 years, without the compounding of dividends. With 143 additional basis points by reinvesting dividends, $1,000 becomes roughly $32,375 -- an increase of almost $7,000 during the same time frame. Over 30 years, the difference between compounding and simply keeping dividends provides even greater returns. A 17.5% return changes a $1,000 investment into $128,170. A 143-basis-point increase from reinvesting dividends raises that amount to $184,210, a massive difference of $56,040.

Dividends make a huge difference with index returns as well. As you can see in the chart below, the S&P 500 returned a cumulative 77% over the past 10 years. The S&P 500 Total Return Index, which factors in dividends, increased 116% cumulatively. Annualized, this works out to 6% and 8% per year for the S&P and the S&P 500 total returns, respectively.

<img src="http://media.ycharts.com/charts/1342119f10cbbb333f864dc87784c593.png" />

^INX data by YCharts

Dividends may seem minute, but reinvesting vastly increases your total return over the course of two to three decades. The differences can add up to tens of thousands of dollars. Dividends do count.

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stockdissector has positions in Microsoft and McDonald's mentioned above. The Motley Fool owns shares of McDonald's and Microsoft. Motley Fool newsletter services recommend McDonald's. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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