Should You Reinvest Dividends?

Timothy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Many companies offer dividend reinvestment plans, or DRIPS, which automatically invest dividends into additional shares of the company's stock. These plans allow you to accumulate more and more shares over time at varying prices, thus increasing your dividend payment at a greater rate than just the dividend growth itself. How much of a difference does setting up a DRIP really make, though? I'll look at three companies which have been reliably paying dividends for many years, Johnson and Johnson (NYSE: JNJ), Verizon (NYSE: VZ), and McDonald's (NYSE: MCD), and show why reinvesting dividends can be a smart move.

The Setup

For each of these three stocks imagine that you bought $10,000 worth of shares at the beginning of 2003. Each time a dividend is paid you buy new shares at the closing price on that day. I'll use the ex-div date instead of the actual payment date since Yahoo Finance has historical ex-div dates readily available. After a decade of this you now have more shares than you started with. I'll compare the results from this scenario with one in which you don't reinvest the dividends and simply keep them as cash.

Johnson and Johnson

Johnson and Johnson has been a reliable dividend stock for decades. At the beginning of 2003 the stock was trading at about $55 per share and paying a $0.205 quarterly dividend. The stock currently trades for around $74 per share and pays a $0.61 quarterly dividend. The stock price has increased at an annualized rate of just 2.29% in that time while the dividend has grown by a much faster rate of 11.52% annually.

Here are the results of the two scenarios for Johnson and Johnson:

If you had simply kept the dividends in cash you would have collected a total of $3,076 in dividends over the past decade while your stock would have risen in value to $13,336, a total collective value of $16,382. Reinvesting the dividends would put the total value at $17,516. This doesn't appear to be a huge difference from the graph, but your portfolio would be worth almost 7% more simply by reinvesting the dividends. On an annualized basis, keeping the dividends leads to 5.06% annual growth rate while reinvesting them leads to a 5.77% annual growth rate.

A more pronounced difference is that by reinvesting the dividends you now have 31% more shares. Your annual dividend payment is about $580 compared to just $441 from keeping the dividends. Here's the annual dividend payments over time for both scenarios.

Verizon

Being a telecom Verizon pays a high-yield dividend, currently around 4.8%. At the beginning of 2003 Verizon was trading at $40 per share and paid a quarterly dividend of $0.385. Currently the stock trades for about $42.50 and with a quarterly dividend of $0.515. The stock has been essentially flat while the dividend has increase by about 3% annually.

Here are the two scenarios for Verizon:

The difference is more pronounced for Verizon than it was for Johnson and Johnson. If you kept the dividend your stock value would be $10,600 after 10 years and you would have collected a total of $4,839 in dividend payments, a total value of $15,439. The reinvested dividend scenario leads to a total value of $18,280. That's 18% more. On an annualized basis the returns are 4.44% and 6.22% respectively.

In this case reinvesting dividends grew your share count by a whopping 72%. An annual dividend of $513 with the original share count is instead $884 with the new share count.

Judging from the Verizon results a dividend reinvestment strategy seems to work extremely well with a high-yield low-growth company.

McDonalds

Both McDonald's stock price and dividend have grown quickly over the past decade. The stock has risen from the mid-teens to around $93 per share and the dividend has grown from $0.40 annually to $3.08 annually. The stock has increased at an annualized rate of 18.88% while the dividend has grown at an annualized rate of 22.6%.

Here are the two scenarios for McDonald's:

Both scenarios showed impressive growth due to McDonald's stock rising so much over the last ten years. Keeping the dividends as cash gives you a total value of $65,967, $9,388 of which is cash from dividends. Annualized growth is 20.76%. Reinvesting dividends leads to a total value of $73,394, or 11.3% larger than the first scenario. Annualized growth here was 22.06%.

Share count grew by a 29.6% with reinvested dividends, creating an annual dividend payment of $2,412 compared to $1,861 with the original share count.

The Bottom Line

While reinvesting dividends over the past decade raised total returns for all three companies, Verizon's results were the most impressive. Even though the stock was essentially flat by reinvesting dividends a total return of 6.22% was achieved. Along with this the total annual dividend payment was 72% higher at the end of the decade than the case where dividends were kept as cash. The conclusion here is that, in some cases, dividend reinvestment will greatly increase your overall return and greatly increase your dividend stream. In other cases it will give you more modest increases. Overall, it’s a good hands-off strategy that will pay off in the long run.

 


TheBargainBin has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson and McDonald's. The Motley Fool owns shares of Johnson & Johnson and 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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