I previously wrote an article that illustrated the potential benefits of reinvesting dividends with several stocks over a relatively short time frame. I wanted to take a moment and focus more closely on The Coca-Cola Company (KO) over a longer time period. Warren Buffett was on to something with this investment. A simple investment back in 1984 would produce a small fortune today without any additional investments. This is the power of dividend reinvestment.
How does this work? If someone had purchased 400 shares of KO back on September 10, 1984 at $60.50 and just reinvested dividends, they would be a millionaire today. While the initial investment is close to $25,000, a significant sum of money today and certainly a relatively larger sum back then, the mathematics and percent returns would be the same for any amount of money. Closing prices from November 9, 2011 were used for this analysis. The following chart shows the detailed breakdown of how the investment has performed over time:
The first step shows the initial investment in 400 shares. The next step is the largest driver of KO returns. KO has been a phenomenally successful company providing significant share price appreciation. Since 1984, KO has had 4 stock splits: one split was 3 for 1 and three others that were just 2 for 1. This means that an investor would have 24 shares today for each share purchased in 1984. Simple math shows that 400 x 24 x 67.03 = $643,488 or a gain of $619,288 over the initial investment. This is a 12.8% return and does not include any dividends. So without question, KO is a bit of an anomaly within the investing world.
The next bucket shows the dividends earned from the initial shares purchased, as well as any shares acquired from splits related to the initial shares. This amount is a staggering $181,544. This reflects historical yields ranging from 1% to almost 4%, a little above the current SPDR S&P 500 Trust ETF yield of 2.0% that is available right now. At this point an investor would have a little over $800,000.
The next two buckets illustrate the impact of reinvesting dividends. While the initial investment provided $182 thousand to purchase additional shares, all of those shares also pay dividends. This second amount totaled $87,874. Almost a third of all dividends received was due to the investment of dividends from that initial investment.
Furthermore, not only do you earn dividends on reinvested dividends, those shares can also appreciate in value. While the initial purchase contributed 9,600 shares to the current total, all the reinvested dividends provided another 7,489 shares. These shares also benefited from KO stellar stock performance, appreciating another $232,593 in value -- close to a doubling of the amount of dividends reinvested.
These last two buckets are critical since they represent the bonus from dividend reinvestment. Almost a third of the total gain is from reinvesting dividends. However, it should be noted that this performance was significantly enhanced from KO's strong overall stock performance. The flip side is that a stock with a higher yield, say a utility type of company, would have an even more exaggerated benefit from dividend reinvestment.
At the end of all this, the investor has a portfolio worth about $1.15 million that paid over $30,000 in dividends in the past twelve months -- a sum larger than the initial investment. Not too shabby.
This article illustrates the benefits of dividend reinvesting and impact of compounding -- earning dividends on dividends. Clearly, one could invest KO's dividends in another security. Furthermore, it should be noted that even if dividends are reinvested, they create a tax liability. However, given KO's strong stock performance and relatively low historical yield, the majority of the gains on the reinvestment are still related to the initial investment. However, over a longer period, or with a stock that has a higher dividend yield, this would flip. It is also important to note that picking another stock and consistently reinvesting dividends might not have the same benefits -- especially if it is an underperforming stock, or worse yet-- goes bankrupt.
Disclosure: I am long SPY.
Additional disclosure: Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.