The Power of the Dividend
In a world obsessed with price movements of stocks, it’s easy to lose sight of what those prices represent — the value of holding a company’s future profit potential. One of the key ways that profit potential turns into profit actualization in an investor’s pocket is the dividend — cash (usually) payments made to stockholders representing a portion of a company’s retained earnings. Retained earnings is found under the shareholder’s equity portion of the balance sheet and represents the amount of earnings a company has left over after paying dividends to its shareholders. Retained earnings is calculated as:
RE = BP + Net Income – Dividends
BP = Retained Earnings at the beginning of the period.
Net Income = Revenue – Expenses
Before further discussion of why dividends can be impactful in the long-term, here’s a plot showing how much of a difference reinvested dividends would make in one’s five year holdings of NASDAQ:FSV compared to holding the dividends as cash and regular price appreciation.
The following plot shows three values over a five-year period:
1) The value of a $100 investment in FSV, with only price appreciation.
2) The value of a $100 investment in FSV, without re-investment.
3) The value of a $100 investment in FSV if dividends were immediately reinvested.
4) The value of a $100 investment in NASDAQ:SPY if dividends were immediately reinvested.
How Does a Dividend Impact a Stock’s Price?
A key thing to note is that dividends will be announced with an ex-date. This ex-date is the date on which one must be a holder of a share in order to receive the share’s dividend. At the close of trading on that day, the effective value of each share may go down by the size of the dividend, because new purchasers will not hold the right to receive the dividend.
That said, once the market opens the next day, the stock price could rebound up beyond its previous close, or continue to lag behind its prior value. This uncertainty is simply due to general market forces that exist on any day of trading. For instance, the company’s industry may be trading up due to some sort of positive news, completely offsetting buyers’ lack of dividend rights…or, conversely, the company’s industry may be trading down due to some sort of negative news.
Index ETFs’ Reinvested Dividend Value Compared to FSV’s
The plot above shows how much reinvested dividends of FSV’s have returned compared to those for the popular ETFs SPY and NASDAQ:QQQ (which track the components of the S&P 500 and NASDAQ 100, respectively, and pay out dividends for their underlying securities). Note that the bars could not be below zero, because a reinvested dividend represents a fraction of a share of a company, and company shares cannot go below zero. Note, too, that the bar for FSV represents the final difference between the red and blue lines on the first graph above.
By looking at the price chart of FSV’s common stock one can see that price appreciation alone misses a fair bit of value if one’s considering holding the stock for a long period of time. This is the case for other equities too; check out all Benzinga’s dividend data here or in an enhanced view on Benzinga Pro.