I wanted to a post in which I walked through the psychological side of investing where I could explain what it means to be a long-term dividend investor that focuses on profits rather than share price, and what ought to be going through your mind as you build wealth if this style suits you. I know ‘holding forever’ isn’t a style that fits the temperament of everyone, but I wanted to share the thought process for those of you interested.
For today’s lesson, we are going to go back in time ten years to 2004. At the time, McDonald’s was the most dominant fast food chain the world, much as remains the case today. Even a decade ago, McDonald’s had already established itself as a company with a track record of growing its dividend for almost three decades (and the reason there wasn’t a dividend before that is because McDonald’s was growing internally at 35% per year), owned extensive real estate holdings because the company values land almost as much as its fast food operations, and had unmatched brand equity mixed with low costs in the industry.
At the time, McDonald’s was trading at 15x profits for a share price between $24 and $33. Let’s say that you purchased stock on the high side—somewhere around $30 per share, and wanted to make it a significant part of your portfolio, so you loaded up on 1,000 shares for a total cost of $30,000 plus commission.
How is life going to play out for you?
In that 2004 year, McDonald’s was making $1.93 per share in profit. Your 1,000 shares were generating $1,930 in net profit, and you would have gotten sent a check for $0.55 per share. You took that $550 per share and plowed it back into the stock by instructing your broker to reinvest the dividends, and you walked away with another 18.3 shares that year.
Those 18.3 shares don’t get many people in the investor community excited, but it is the first step on the path towards building permanent wealth. In the next year, McDonald’s grew its 2005 profits to $1.97 per share. Now, you have 1,018 shares generating $2,005 in profits, and as the business grew, McDonald’s rewarded you with another dividend—this time higher!—in the amount of $0.67 per share. With those 1,018 shares now working for you, you received $682. As is often the case with a growing business, the price of the stock increased so you had to pay $32 per share to reinvest your dividends. That’s okay, the train still moved ahead—you picked up 21 more shares this time, increasing your total to 1,039 shares.
By the time 2006 came around, you were starting to get the hang of this thing. McDonald’s profits grew to $2.30 per share, meaning your shares were now generating $2,389 in profits per share. The dividend this year increased to $1 per share—you’re starting to realize what can happen when you own a dividend growth stock at the right time during a good year, and you received $1,039 in dividends that got reinvested at $38 per share, netting you 27 more shares.
In 2007, your 1,066 shares started generating $2.91 in profit ($3,102 total) and you collected $1.50 per share so that you got a check for $1,599 that repurchased 30 shares at a price slightly above $53 per share.
Now, the recession is coming. Most analysts act as if someone buys a stock at a peak right before a fall, and then is helpless in that moment. Very rarely does the analysis take into account what it’s like for someone who has been holding the stock for a bit.
When McDonald’s paid out a $1.63 per share dividend in 2008 and $2.05 dividend in 2009, you were in the process of adding 68 new shares to your account. That matters. When you have 1,164 shares in your account, rather than the 1,000 that you started with, the effects of a recession.
The best long-term investors would see the growing profits and growing dividends during the financial crisis and not be too worried by the stock price that fell from $67 to $45 per share. But here’s the thing—someone who had held the stock since 2004 and bought at $30 was still up $15 per share by the time the financial crisis lows came around, and plus, he now had an additional 164 shares to his name.
You invested $30,000. You had 1,164 shares in 2009. For your net worth in McDonald’s stock to fall below the $30,000 mark invested in 2004, the price of McDonald’s stock would have had to fall below $25.77 per share in 2009. The years of growing profits and reinvested dividends build up a bit of a cushion each year, which largely goes unnoticed by most investors that aren’t into this income stuff.
You got through the crisis unscathed. The process repeated each year from 2010 through 2014, and I won’t walk you through the particularities of each year, but those $12.06 in dividends per share paid out from 2010 through 2014 helped your account grow nicely. It gave you over $14,000+ in dividend income that added 171 more shares to your account.
In the case of McDonald’s, it’s not as simple as saying those 1,000 shares producing $1,930 in profit grew to $5,750 in profit ($3,240 declared as dividends) in 2014. You also picked up 335 shares of McDonald’s from 2004 through 2014. The dividends paid out, plus reinvested, came to represent $1,926 in profit in their own right, and $1,085 in annual dividend income all their own.
And, of course, those 335 shares came to be worth $33,500 of their own, so effectively, the dividends became worth more than your standalone investment in McDonald’s stock. When you find a growing company, and stick with it for a while with reinvested dividends, you get great results when you let the interplay of reinvested dividends that add capital to your stock mixing with a payout per share that increases each year. That $30,000 in McDonald’s stock became 1,335 shares paying out $4,300+ in annual income. You just have all these virtuous interplays in which dividends buy more shares which then pay out dividends of their own, but can also be capitalized at a rate of 17-18x earnings if sold in their own right. It’s such a predictable way to get rich, if you give it time.
Originally posted 2014-12-19 08:00:08.