For those of you who have been reading this site for a while (God Bless you!), you know that it is no secret that the cash payouts of high-quality firms contribute a large, hidden part of total stock returns that is not readily apparent when you look at a stock chart and limit your thinking solely to the terms of a company’s stock price.

But something especially incredibly happens when you combine a holy trinity of wealth creation: high current dividends, plus a high dividend growth rate, and then mix it with the decision to reinvest the cash into even more shares. Finding companies with high current dividends and high future dividend growth rates is rare, but why should extreme wealth creation be all over the place? That would defeat the art of investing, and take the fun out of it.

One such company that has, over the past twenty years, managed to combine a very high dividend per share growth rate with a high current dividend (at the time of your initial purchase price) is Kinder Morgan Energy (KMP).

Over the past twenty years, the company’s distribution has increased from $0.55 per share to $5.26 per share. That is awesome. That is life changing. It is one of those things that proves the adage “you only have to get rich once.” But as awesome as the almost ten-fold increase in dividend income (err, technically it’s called “distribution” income because that is the jargon of the general partner universe) appears, it could have been fantastically amplified if you had chosen to reinvest along the way.

Take a look at this F.A.S.T. Graph, courtesy of Chuck Carnevale, to see what would happen if you chose to reinvest your Kinder Morgan shares for the past twenty years.

The share base, which began at 1,250 shares in 1993, would have grown into over 4,977 shares today. That dogged, relentless increase in the share count is hugely responsible for drowning you in income over time—the tandem of an increasing share count and a high organic dividend growth rate is the best recipe I know for generating giant gobs of easy, passive income over the course of your life.

Without reinvesting dividend, you would have gone from collecting about $780 right off the bat in 1993 (the 1993 figure is lower because it only reflects one quarterly payout) to collecting a forward-looking yield of $6,748 in income today. That’s a 67.48% yield on cost over twenty years, which is crazy impressive.

But the numbers enter “Is this real?” territory once you allow for cash reinvestment, which doggedly increased your share count along with the increase in the distributions. For the investor that saw his share count increase to 4,900+ shares due to dividend reinvestment, his initial dividend income of $780 annually turned into $26,880 each year going forward. He blasted through the magical moment in which you collect more in cash distributions annually from an investment and is now receiving 2.68x his initial total investment every twelve months. It’s gotta be wild receiving more in distributions every six month than you originally put into an investment.  Long-term Kinder Morgan ownership gives you a glimpse into what winning at life with your investments looks like.

By the way, as an aside, I’m sure some of you see the payout ratios of 200%, 300%, 400%, and so on, and probably wonder how an arrangement like that is sustainable. The answer is because with these partnerships, there are giant depreciation costs upfront that make it look like a company is earning a lot less than is actually the case. It’s almost the equivalent of how real estate investment trusts need to be measured in the funds from operations that are created by each share rather than the traditional earnings metrics that get used.

With something like Kinder Morgan, you ought to focus on the cash flow per unit. In 2011, each unit generated $4.53 in cash flow while paying $4.58 in distributions. Basically, all the profits got returned back to you as cash, and that extra nickel per share in income is considered a return of capital in which you receive a smidget of your initial investment back as a distribution (this is why partnerships give out “distributions” rather than “dividends” because dividends generally only refer to profits alone, whereas distributions refer to profits plus some modest returns of your own principal).

In 2012, Kinder Morgan generated $5.29 in cash flow per unit, while paying out $4.85 in distributions. In  this case, the distribution did not exceed the cash flow per unit. For those of you who realize that all the cash flow is getting returned to shareholders, you might wonder: How then does Kinder Morgan grow? The answer is that it issues new shares. In 2011, the cash flow generated by the pipelines had to get split up among 336 million shares (commonly called “units”). Now, the cash flow has to get split up among 440 million units. This isn’t dilution like you see with some companies that pay executives lavishly, but rather, it provides them the capital to grow. For instance, Kinder Morgan took a big chunk of those 100 million shares issued and made a giant $5.4 billion investment into the Trans Mountain Oil pipeline in British Columbia. It’s going to take three to four years for the project to start generating cash for the owners, but it offers an insight into how shares get issued to make investments that will hopefully increase the cash flow generated at a rate that exceeds the amount of dilution created by the share issuance.

This is the type of reason why I am so interested in the high-yielding oil behemoths like BP and Royal Dutch Shell. They are a bit different from other dividend growth stocks. They offer a high current yield, and it is the reinvestment of that high current yield that increases the share base and allows you quietly get rich, right there in plain sight. We all know what happens when you get a growing dividend, but when you can find an investment that has a high current yield for reinvestment, the story gets a lot sweeter.

Originally posted 2013-12-18 11:08:14.

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