I have a few shares of stock that was given to me by a company I work for. I do not contribute any additional money to this account, but it does pay a small dividend, only 6 cents a share. (For a explanation of dividends, click here to read a previous post). I haven’t decided what to do with these shares since it is such a small amount and the holding company will charge a substantial amount in order to liquidate them. So I let them sit there and watch what they do. Here is what is really cool about them right now – the re-invested dividends.
Follow this example to understand how re-invested dividends in a slow market can make a lot of money (amounts have been adjusted to make the discussion more realistic, but are true to the same ratio in the entire example): In December 2006 the dividend check was $16.20. The stock price was $18.38, so the dividends were re-invested back into the account and bought me almost another full share. That means the next quarter’s dividend check would be even higher because there is another share of stock issuing me a dividend. By June 2007, my dividend check was approaching $25.00 when a share of stock was $21.85. Every quarter my shares of stock increased, which gave me more dividends the next time, and my shares of stock increased again, and the cycle continues.
Now for the interesting part: In February 2008 the dividend check was $24.70 and stock price $11.67. The stock price had fallen more than 50% but dividends were still issued at the same rate (each share gave me 6 cents in dividends). Now the re-invested dividends were purchasing two more shares instead of one. The market continued to stink and the stock droped to $7.60 in February 2009, the dividend check was $25.20 and it bought me 3 more shares.
What happens when this market fully recovers to the same prices from 2007? All my shares, including the new ones bought from re-investing dividends, will make this account worth quite a bit more than two years prior. And it didn’t cost me a dime.
This example is very similar to how compound interest works, which I will save for another “word of the week” discussion.