Dividends, plus the passage of time, can make a stock price chart look silly because of the easily understated nature of dividends in the wealth-building process.
That’s it. That’s the secret to building wealth. It’s amazing how much different investing appears when you only look at a stock chart (such as you typically see on CNBC) and then step back and adjust it for the passage of time to get a full picture of a company’s total returns.
Because dividend payouts typically amount to 2%, 3%, 4%, or 5% in a given year, they can become quite easy to neglect, perhaps regarded to the untrained eye with the same appreciation given to a dollar bill found in a seat cushion.
But if you find a company that either has a law starting yield with a high dividend growth rate, or has a pattern of returning a good chunk of income to shareholders, you can start to experience the transformative effects of dividend investing within 5-15 years.
To give an example, let us consider BP. The oil giant, which had a large spill a few years ago that most of you are familiar with, is on the short list of disappointing investments that intelligent investors could have made over the past decade (others include General Electric, Wachovia, etc.). But if you’ve been holding the stock for ten years or so, the dividend payouts have bailed you out in a big way (and the stock price becomes increasingly incomplete with the passage of time).
To make the numbers specific, BP traded at $40.65 as we entered the 2003 calendar year. As of September 12th, 2013, BP traded at $42.10. If you only take a look at the stock price, it looks like you waited ten years only to see your investment increase 3.56% in total over the entire period.
But when you take into consideration the contribution of dividends over the past decade, the numbers start to look like this: a $15,000 investment in BP would have paid out $10,329 in total dividends over the past decade. In reality, BP shareholders have reaped a total return of 59% over the past ten years, combined with reinvested dividends. That’s a much better story than what the stock price tell you. Sure, it only works out to 4-5% total returns per year, but considering the scope of things that went wrong at BP, the fact that you have positive returns when you stretch out the time period a bit and include the dividends paid is something worth getting excited about.
Look, investing isn’t just about having that magical stock ownership position that compounds at 13-16% per year for 15 years. It’s also about limiting the damage of your mistakes. There’s a reason why it makes sense to focus most of your investing efforts on the megacap blue-chip stocks that pay dividends—when you give them enough time, those paltry dividends become a fantastic defense mechanism that allows you to quietly build wealth, having more money coming in year after year, while most of the world doesn’t spend much time thinking about what happens when you take small amounts of money and relentlessly let it compound upon itself. Dividends+Time+A Profitable Company=Awesome Defense Against Calamity.
Originally posted 2013-09-14 14:43:57.