The Secret of Reinvesting Your Dividends
Written By TarikWant to know The Secret to successful investing?
The Secret is DRIP accounts or Dividend Reinvestment Plans that use the stock’s dividends to repurchase more shares for you without any extra charges. You gain more shares of your investment, without worrying about buying the stock whether stock’s price is cheap or not, another huge advantage of DRIPs over regular dividend earnings.
When stocks pay a dividend, shareholders receive a quarterly (sometimes bi-annual) sum of money, depending on the company’s dividend yield and dividend rate. The dividend yield is always changing, but the dividend rate remains the same until a firm’s board of directors agrees on a dividend increase.
To calculate the yield, we divide annual dividend per share by stock’s price per share.
When the stock prices falls, the dividend yield increases, and shareholders are paid with a larger cash sum with each dividend payment. On the other hand, the yield shrinks when a stock’s price increases, thus lowering the quarterly cash payment without altering the dividend rate.
DRIPs also reward investors during bear market situations when the general market talk is fairly negative.
Here’s an example to better clarify the positive effects of a bear market on your dividend-paying stocks.
Wal-mart (WMT) stock is currently hovering around $47 a share. If shares lost 50% of their value, then the share price would decline to around $23 to $24 per share, leaving most Wal-mart investors distraught and very upset.
Notice I mentioned “most” above because there will be a small contingent of investors who know exactly whats going on. The falling stock price allows Wal-Mart investors to repurchase more shares due to the dividend yield increase, and they actually end up owning more shares of the stock at a cheap price.
The Bear Market increased Wal-Mart’s dividend yield by 86%, which pays you twice as many shares than you were holding before. Now you can buy additional shares of stock a much lower price than before the bear market/price crash. Most importantly, your broker is repurchasing shares more shares at no cost to you.
This method only works for damaged stocks, not damaged companies. Investors rediscover damaged stocks, but they shun damaged companies. Always make sure your investment agrees with the former, not the latter.
Helpful resources on Dividend Investing:
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Post/Read Comments
December 6th, 2006 at 3:52 pm
I am a big believer of dividend reinvestment and have dividend-paying stocks, mutual funds and ETFs and all the dividends (except those with Scottrade which doesn’t support dividend reinvestment) were reinvested. Another benefit of reinvesting dividend is that stock/mutual fund price is usually lowered by similar amount after the dividend payout and the reinvested dividend can buy more shares.
I have a question about your statement “pays you nearly twice as much cash than you were earning before.” If the dividend rate on a per share basis is the same, how can you get more if the number of shares you have remains the same? I think only the yield is higher, but not the actual amount you receive. Did I miss something?
December 6th, 2006 at 4:09 pm
My wording was slighty off. What I meant was “pays you twice as many shares than you were earning before.” I’ll make the necessary change. Here’s my extended explanation on the 2x share earnings.
Example:
10 shares at $47. yield = 1.6%
so we can buyback $7.36 worth of one Wal-mart share, equivalent to 1/8 of a share.
10 shares at $24. yield = 2.7%
now we can buyback $6.48 worth of one Wal-mart share, equvalent to 1/4 of a share.
You can now buy twice as many shares than before. That is why companies raise their dividend during poor stock performance episodes. It rewards shareholders with more shares during negative stock rallies.
Thanks for the question.
Which mutual funds do you hold? I’m looking to add one or two to my ROTH IRA.
December 7th, 2006 at 7:34 am
Now that makes sense.
I own a bunch of mutual funds, most of them pay annual dividends. One that pays monthly dividend is ADVDX. Another one DODGX (closed to new investors) pays quarterly dividend. I also have PEY, an ETF, that distributes every month.
December 10th, 2006 at 12:26 pm
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