There have been many articles written on the benefits of reinvesting dividends. In most articles, either one or maybe a few scenarios are shown to demonstrate the generally positive impact on future dividend income from a stock. But what are the broader patterns to this impact?
In my recent articles, I have used a model to analyze sensitivities associated with targeting an income level. I altered this model slightly to generate data regarding the impact of reinvesting dividends over a ten year period as a function of 1) the going-in yield-on-cost, 2) the dividend growth rate and 3) changes in the stock price. I provided three options for each item: 3%, 4% and 5% for going-in yield-on-cost, 3%, 5% and 7% for the dividend growth rate and 0%, 5% and 10% for price growth.
For simplicity sake, dividends are assumed to be received annually (not the typical quarterly) and growth rates are applied evenly throughout the ten years. As we know, this is not realistically how investments perform but, nonetheless, it is still a valuable way to show the relative impact of the three variables on the benefit of dividend reinvestment. As with my previous use of this model, price growth is only relevant to determine how many shares are purchased when dividends are reinvested. Finally, the impact of taxes is ignored as this is assumed to take place in an IRA or other similar tax-advantage account.
The use of three variables each with three values yielded 27 results as follows:
Click to enlarge
The results show that the variable that has most dramatic impact on the value of reinvestment over a ten year term is going-in yield on cost. For dividend growth rates, the impact on reinvestment returns is quite muted. Finally, as discussed in previous articles, stock price increases actually decrease the impact of reinvestment as fewer shares can be purchased when future dividends are reinvested.
Not surprisingly, if expected price growth and dividend growth are similar, you can say that reinvestment returns will enhance your total dividend returns per annum by, roughly, the going-in yield.
On a gross basis, the impact of reinvestment varies from a moderate to dramatic depending on the variables. In some cases, particularly for stocks with slower growing dividends, the impact of reinvestment exceeds the impact of the dividend growth itself.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.