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 NYSE:LII 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 LII, with only price appreciation.
2) The value of a $100 investment in LII, without re-investment.
3) The value of a $100 investment in LII if dividends were immediately reinvested.
4) The value of a $100 investment in NASDAQ:SPY if dividends were immediately reinvested.
Dividends will be announced with an ex-date. This is the date by which one must hold a share in order to receive the dividend. Right when trading closes on that day, the market price of each share is expected to drop by the size of the dividend, because anyone now purchasing the stock will not 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.
LII’s Reinvested Dividend Value Compared to That Of Index ETFs
The plot above shows how much reinvested dividends of LII’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 LII represents the final difference between the red and blue lines on the first graph above.
Finally — what’s the point of all this? The key insight to take from this article is to note how much value simply looking at the price chart of LII’s common stock misses if one’s considering holding the stock for a long period of time. Dividends surely can matter.