Monday, February 4, 2013

Don't Forget the Dividends

Back in February of 2008 I bought 400 shares of AT&T (T) for $14,448.95. That works out to a cost basis of $36.12 a share including brokerage fees. Today those shares sell for $35.51, a loss of $244.00.

In November of 2008 I bought another 100 shares of AT&T for $2,713.95, or $27.14 a share. Combine the two buys for a grand total of $17,162.90. Today 500 shares of AT&T would be worth $17,755.00. That would be a profit of $582.10 or 3.4%.

However, I do not current own 500 shares of AT&T. I own 651.5847 shares valued at $23,137.77.

AT&T pays a dividend of $1.80 a share. That works out to 5.1% at its current price. I elected to reinvest my dividends back into more shares of AT&T. This is commonly called a Dividend Reinvestment Plan (DRIP). It is free and it is automatic.

In this case dividends and the magic of compound interest turned a meager profit of $582.10 (capital gains) into a total profit of $5,964.87 or 34.7%, nothing to write home about but not too shabby.

Before the last crash, dividends were out of fashion. They are taxed at a higher rate than capital gains. Instead of increasing dividends with increasing profits companies were using their extra money to buy back shares. This tends to increase the value of the shares left in the market. Of course the company can dump those shares when they need to raise some quick cash. This would tend to lower the value of your shares. Dividends are money in your hand. You can spend it, reinvest it the stock that generated the dividend, or you can choose to invest it in something else entirely, but that money can not be taken away from you.

History shows that roughly ½ of all stock market profits are generated by dividends. A good dividend is not a sufficient reason to buy shares in a particular company. There are many other things to consider before making that decision. However, don’t forget the dividend. The rule of 72* tells us that a 6% dividend all by its lonesome self will double your money in 12 years with no increase in the value of your shares whatsoever.

And…Hey! Let’s be careful out there.

*The rule of 72 states that the value of an investment will double in the number of years given when 72 is divided by the interest rate.

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