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Long/short equity, event-driven, portfolio strategy, industrials
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We all love dividends, and many of us love to reinvest them once we receive them. Reinvesting dividends can increase the size of one's portfolio significantly over the years, but there are debates about how to reinvest these dividends. Should someone reinvest the dividend as soon as receiving it, or should one wait for the stock price to fall in order to reinvest the dividend? What if the stock price is very high by the time the dividend is issued and one wants to wait till the price falls in order to reinvest?

I looked at this case, using an example - AT&T (NYSE:T). Let's say someone bought 100 shares of AT&T in 2002 and held onto those shares till today. Also assume that this person kept reinvesting his dividends as soon as he received them. Looking at the historical dividend rates of AT&T, this person's AT&T positions would keep increasing at this rate:

Year Number of Total Shares
2003 104.30
2004 109.90
2005 118.82
2006 125.75
2007 131.53
2008 136.39
2009 144.20
2010 153.70
2011 163.53
2012 173.16

It doesn't look bad at all. But what if this person held onto his dividend checks and waited for the stock to fall to reinvest? First, let's look at the lowest price AT&T shares traded for in each year.

Year Number of Total Shares
2002 20.15
2003 20.60
2004 23.10
2005 22.2
2006 25.28
2007 37.63
2008 22.42
2009 23.77
2010 24.17
2011 27.41

Now, if one held onto his money for a year and reinvested it at the lowest price every year, how many shares would he have had at the end of 10 years? Let's look at it.

Year Number of Total Shares
2003 105.29
2004 112.23
2005 118.30
2006 125.18
2007 131.77
2008 136.74
2009 146.50
2010 156.61
2011 167.50
2012 178.01

It seems that he would have 3 more shares than someone who just reinvests as soon as receiving the dividend. Why? Because the individual that reinvested his money every quarter was able to enjoy quarterly compounding while those who waited to invest at the year's lowest did not get to enjoy that. Of course one could reinvest his or her money every quarter instead of every year as well, but the problem is that most companies that issue dividends are defensive stocks and their value does not change much from quarter to quarter.

Another approach would be to save all the dividend money till the next market crash, and reinvest the money when that happens. Historically, the market crashes or plunges every 5-6 years, so patient investors may find value in timing such crashes but they may also miss out on many compoundings during this time.

In conclusion, there are different ways one can reinvest the dividend money in order to increase one's position in a stock. Everyone should pick the best way for them, keeping their objectives and timeframes in mind.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.