One of the ridiculous components of the annual “Forbes 100 List” that outlines the richest people in the world is that it is written with the frame of reference that every member of that list is actively trying to get richer over time. In the case of Carlos Slim, that is undoubtedly true. In the case of Bill Gates, that is undoubtedly false.
When Microsoft went public in 1986, Bill Gates owned 46.7% of the stock. Microsoft is now a company in the $350 billion range. Had Gates decided to let his ownership stake silently compound without any interference from him, he would be sitting on a $163 billion fortune (and that is before taking into account Microsoft’s dividends), permitting him to likely live out his days as the richest person in the world.
Instead, Gates has chosen to get serious about charity, selling off his ownership stake to save lives. The other thing he is doing is selling Microsoft stock to diversify his wealth into things like Minnesota’s electric power company Otter Tail.
One of the perennial questions that I receive from readers is this: Should you reinvest your dividends automatically into the company that paid them out, or should you pool them together to make new investments altogether?
The answer to that question is always some form of “it depends” but I will say this: Microsoft is exactly the type of stock that is well-suited for conservative accounts to take their dividends and pool them together for investment elsewhere. It has a growing dividend that will give you more and more cash each year to make new investments, but given its reliance on tech products (e.g. Microsoft must keep up with the times whereas all Hershey has to do is keep making chocolate) it could be wise to derisk the stock by allocating your dividends from Microsoft elsewhere.
How might this scenario play out?
Imagine if, five years ago, you saw Microsoft trading at $20 per share for a valuation of only 13-14x profits. Even though the stock subsequently fell to the $14-$15 range as part of the general selloff associated with the financial crisis, you saw that the company had a treasure chest of tens of billions of dollars, and you figured Microsoft Word and all his friends would be part of our world for some time to come.
Here’s what would have happened: if you bought $10,000 worth of the stock for 500 shares total, you would have collected: $0.52 in both 2009 and 2010, $0.64 in 2011, $0.80 in 2012, $0.89 in 2013, and at least $1.12 in 2014 (I assumed a $0.28 payout for the final quarter of 2014, but Microsoft typically raises its dividend by that point so the exact figure should be a little higher).
Each share of Microsoft that you owned would have collected $4.49 from 2009 through 2014. For someone who paid $20 per share, you would have gotten a little over 22% of your investment amount back in the form of dividends. If you scooped up 500 shares, Microsoft’s Board would have paid out to you $2,245 that you could have used to start building a position in a company that you know will be around decades from now pumping out dividends for shareholders, like Hershey. Then, you’d also have $2,245 worth of Hershey stock generating their own dividends for you as well, and that’s how a virtuous cycle gets set in motion.
Over the next five years, things could get even more interesting as Microsoft’s dividend has a fair chance of crossing the $2 per share mark. At that point, you’d be receiving $1,000 each year to make new investments elsewhere (the basis for that projection is that Microsoft still continues growing at the mid single digits and also boosts its dividend payout amount from the 30-40% range to something closer to 50%).
At that point, you could just hook up your Microsoft shares to a separate bank account, run an automatic investment program through Computershare to buy Exxon (or whatever you end up selecting) to the tune of $83 per month. The exact specifics and details of your strategy may vary, but it is entirely possible to reduce the technology risk inherent in being a Microsoft owner while using the growing dividends to build up a mini blue-chip portfolio of your own elsewhere.
When Microsoft announces its annual dividend raise, you can do likewise by increasing the amount of your monthly investment into the blue-chip stock that you select. I could easily envision a world in which someone with sizable chunks of stock in Apple, IBM, and Microsoft takes dividends from those stocks and sets up perpetual monthly investment into Nestle, Exxon, and Dr. Pepper free of charge through Computershare or whatever transfer agent you’re dealing.
That being said, worrying about dividend allocation isn’t really something that deserves attention until the dividend checks start to reach the hundreds of dollars. Fretting over the optimal way to allocate $5 in quarterly Microsoft income is just a waste of mental energy and perhaps fees depending on the circumstances, and at that stage, your time should be spent improving your savings rate so you can get more money to invest each month.
In Bill Gates’ case, he takes the Microsoft dividends and deploys them elsewhere into new investments and charitable contributions. He also sells Microsoft stock regularly as well, but that’s because if he only re-allocated dividends alone he’d still die with over 90% of his wealth in Microsoft. For the retail investor sitting on a few hundred or even thousand shares of Microsoft stock, it seems wise to appreciate it’s growing dividend over the long-term while recognizing that IBM has been the only tech company that has sense to own generation after generation, and to hedge against this tech risk by using the dividends to purchase high-quality companies against the possible that Microsoft may not automatically be a cash cow forty years from now.
Originally posted 2014-09-10 08:00:36.