The Truth About The Impact Of Dividend Reinvesting


There is a growing trend towards doing-it-yourself (DIY) portfolio management.  Many individual investors have become disillusioned with professional investment management at various levels, to include mutual funds as well as custom-designed professionally-managed portfolios. Consequently, they have become motivated to take their financial futures into their own hands and manage their own portfolios.

Generally, I am in favor of this action as long as several conditions are met.  First of all, the individual do-it-yourself investor (DIY) must be willing and able to commit the time, work and effort necessary to effectively manage a portfolio.  They also need to have the proper tools and research at their disposal. In our Internet age, there are numerous free financial blogs and websites at the do-it-yourselfer’s disposal.  However, there are also many reasonably priced research subscription sites that ought to be considered as well.

But perhaps most importantly, I believe that the individual do-it-yourself investor (DIY) must have accurate and relevant information and knowledge at their disposal.  Frankly, I believe that this particular requisite is challenging to get right for professional and lay investors alike.  My reasoning is based on my experience that many widely-accepted “sacred cow” investing theorems and concepts are, in fact, either flawed , inadequate or plain wrong.  Consequently, their erroneous conclusions and mistaken notions offered as facts could lead investors down the wrong paths.

In my experience, there are a couple of primary reasons for the deficiencies that many investment axioms often contain.  First and foremost, much of what is promoted as truth is often based on numerous studies that are conducted utilizing data that is too generalized to be of value.  For example, there are many studies debating broad concepts such as value versus growth, or the merits of dividend paying stocks versus non-dividend paying stocks. My problem with these studies lies in my observation that they are often comparing apples to oranges. Moreover, they often confuse correlation with causation, which is a major fallacy in logic.

Allow me to elaborate in order to make my point more clearly.  A study conducted comparing dividend paying stocks versus non-dividend paying stocks could lead to very erroneous and even unreliable conclusions. For example, there are many categories, classifications and distinct differences among dividend paying stocks.  Some grow very fast, some slow, some have higher yields and large payout ratios, and others lower yields and low payout ratios.  Moreover, there are numerous differences and nuances between the two extremes.

To put it simply, I believe it is unfair and even possibly misleading to conduct a study that is so overly general that vague conclusions are derived and presented as fact. For example, turning to non-dividend paying stocks, some don’t pay a dividend because they are not financially strong enough, while others don’t pay a dividend because they are growing so fast that they need every dime of earnings and capital they can get their hands on to continue to feed their growth.  Putting these two extremes in the same study cannot help but produce misleading conclusions.

When attempting to explain this, I like to reframe an old adage where I say “the Angels are in the details.” In my experience, true information and knowledge that can be applied as wisdom will most always come from a more individualized detailed analysis. In other words, individual investors would be better served by understanding all the differences and nuances of various classes of dividend paying stocks over having a general notion that dividends are either good or bad.

Consequently, the goal of this article is to elaborate, by example, on the many different kinds of dividend paying stocks that are available for investors to invest in. With a deeper understanding of the differences within the broad classification -dividend paying stocks- individual investors should be empowered to make more intelligent decisions regarding whether or not a specific type of dividend paying stock fits in with their investment profile or not.

But equally as important, my goal is to squelch many of the myths associated with dividend growth investing specifically, and/or investing in dividend stocks in general. For example, there are widely held notions such as:  The majority of stock returns come from dividends, or that dividend paying stocks perform better than non-dividend paying stocks.  In truth, both of the foregoing statements are true and false at the same time.  Because the true answer is, it depends on the individual stock, dividend paying or not.  As Mark Twain so eloquently put it:

“it isn’t what we don’t know that gets us in trouble.  It’s what we do know that just ain’t so.”

What I believe Mark Twain was basically telling us is that if we hold falsehoods as absolute truths, we can be prone to making egregious errors. When dealing with something as important as managing your own money, you literally cannot afford to make mistakes, especially obvious ones, based on over-generalizations of the facts.  Nor does it serve us to believe something that is not true.

Therefore, what follows will be several examples of different kinds of dividend paying stocks offered in order to provide deeper insight into several commonly held notions. As I examine each example, I will ask and answer important questions that I believe will provide greater investor insights into the actual importance and contribution of dividends versus capital appreciation.  With each example, I will focus on how much return comes from dividends and how much comes from capital appreciation.  I will also illustrate the precise benefits and effects of dividend reinvestment as it applies to different types of dividend paying stocks.

The Many Faces Of Dividend Paying Stocks

There are many dividend growth investors who are practitioners and enthusiasts of dividend reinvestment in one form or the other.  Some will use automatic DRIP (dividend reinvestment programs), while others will collect dividends and reinvest them at their discretion.  Personally, I think both approaches are valid, but I personally tend to follow the latter of collecting dividends and reinvesting them at my own discretion. Once again, there are advantages and disadvantages to both approaches, but I feel that both work very well.  Discipline is the key to any successful dividend reinvestment program.

Regardless, and more to the theme of this article, one of my primary objectives is to provide the reader deeper insights into how much contribution to total return that dividend reinvesting makes. And secondarily, how big a part of total return should investors expect to receive from dividends versus capital appreciation. Furthermore, I will illustrate that this varies based on the growth potential of the unique individual categorization of the dividend stock being examined. Moreover, I want to illustrate how wide-ranging the differences are among the various types of dividend paying stocks.

In order to answer these important questions and illustrate these points, I will utilize F.A.S.T. Graphs™, the fundamentals analyzer software tool and its recently added reinvestment of dividends performance calculation option. But before I do, there are a few positioning statements and

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