Let’s pretend that it’s January 1, 1980. A famous hedge fund manager approaches you and says, ‘Hey, if you give me $25k, I’ll be able to turn it into a million dollars within twenty-one years.’ If you believed this hedge fund manager was capable of keeping his promise, you’d probably scramble to do whatever you could to come up with the money. After all, $1 million in the bank can easily throw off $40,000 per year in income, and that single investment would single-handedly ensure that you wouldn’t have to spend your golden years eating cat food. But the funny thing is, you could have achieved those stellar returns without entering the opaque world of hedge funds merely by investing $25,000 into the classic blue-chip stock of Johnson & Johnson (NYSE:JNJ) on January 1, 1980.
It’s not like Johnson & Johnson was an up-and-coming company in 1980. By then, it had consumer brands on every store shelf, ranging from Tylenol to Band-Aids, and had already developed a reputation as one of the bluest of the blue chips. In February 1980, Johnson & Johnson paid out a dividend of a penny per share. It would have continuously grown all the way to $0.18 quarterly in 2001 when your initial investment would have first crossed the $1 million mark.
If you held on to those shares today, you would be enjoying a $0.57 quarterly payout. Johnson & Johnson’s impressively relentless dividend growth (along with, of course, increasing earnings) has enabled investors to reap excellent returns with a company that had already established itself as a premier large-cap.
Looking at the investment growth and ever-increasing dividends over the years in relation to the initial $25,000 investment is almost jaw-dropping:
In 1980, your $25,000 investment would have given you a split-adjusted 325 shares that paid out a penny per share in a quarterly dividend.
By the fourth-quarter dividend payout of 1985, your 325 shares would have turned into 985 shares (mostly due to a 2-for-1 split) worth just over $49,000 that would have paid you $0.02 per share in quarterly dividends.
In 1990, your 985 Johnson & Johnson shares would have turned into 1,989 shares (another 2-for-1 split accounting for the rapid share increase) that each paid out a $0.043 dividend, worth a little over $130,000 in total.
Looking ahead to 1995, you would be the proud owner of 4,070 Johnson & Johnson shares (again, another 2:1 split) that each threw off quarterly income of $0.083. At this point, your investment in Johnson & Johnson would be worth just shy of $325,000. Not bad.
Fast-forward to 2001, and you would have crossed the $1 million mark, assuming that you had continued to diligently invest your dividends. By the end of 2001, you would own 16,975 shares trading at $59.92 per share and paying out $0.18 per quarter, or $0.72 annualized. You would be receiving $12,222 in dividends, which would constitute a dividend yield of 48.8% on your original investment. I think it’s incredibly illuminating that you could turn $25,000 into $1 million in just twenty-one years with the common stock of a well-known consumer staple—isn’t that the type of return that people hope to achieve with hedge funds?
But there are a couple of caveats that we ought to keep in mind. First of all, we have to take into account inflation. Coming up with $25,000 in 1980 would have been the equivalent of coming up with $46,900 in 2001 dollars. But that shouldn’t necessarily be all that discouraging, because the favorable proportional growth holds constant no matter the initial investment. Let’s say you were only able to purchase $5,000 worth of JNJ stock in 1980. That would still be worth $203,000 in 2001. Congratulations. You have enough money to buy a house.
Another consideration that you can’t ignore is the effect of capital gains taxes. While the Bush tax cuts reduced the amount of taxes on dividends to 15%, that doesn’t negate the fact that you would have had to cut a much more substantial check to Uncle Sam during the 1980s and 1990s. And one thing I’m sure that we all can agree on is that a 30%+ tax on dividends takes some of the magic out of compounding. If you have to pay a third of your $12,222 dividends in 2001 to the tax man—you’re either going to have to sell some shares or come up with a few thousand dollars on your own to pay the taxes on your reinvestment.
From 1980-2000, Johnson & Johnson shareholders would have generated a total of slightly over $135,000 in dividends, and the aggregate amount of taxes paid would have been 30.3%, costing you just shy of $41,000 in taxes. Your Johnson & Johnson stock would not have hit the $1 million mark post-dividend taxes until your total investment reached just over $1,041,000 in November 2001. Click to enlarge:
Click to enlarge
Now, some of you may be wondering, what would happen if you hadn’t touched that $25,000 investment in Johnson & Johnson to this day? You would currently own 21,407 JNJ shares trading hands at $63.14 per share, worth a total of $1.35 million. You would be receiving $2.28 per share annually, giving you $48,807.96 each year in dividends, which is almost double your investment from thirty-one years ago. That, my friends, is why Albert Einstein called compound interest the eighth wonder of the world.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.