Back in 2003, PepsiCo Inc. (PEP) made headlines announcing its Pepsi Billion Dollar Sweepstakes. Undoubtedly the goal of the competition was to drive sales and to create marketing buzz. The competition ran from May 1 to September 14 of 2003, culminating in a special television show involving 1,000 contestants, several dice, and a chimpanzee. Unfortunately, for viewers, (but perhaps fortunately for Berkshire Hathaway Inc. (BRK.A) who underwrote the policy for PEP), nobody won the billion dollar prize. However, one individual took home a guaranteed prize of $1 million. This is one way to make a million through PEP. However, most likely, others have also made a million with PEP. These individuals would be loyal PEP investors who invested every quarter as well as reinvested their dividends.
Chimpanzee: Not Required
An investor initially purchases 50 shares of PEP in early 1977. These shares cost about $3,600, which was a large amount of money for the average person in 1977. All dividends would be invested into the stock as well as some additional money. Starting in 1978, the investor would also invest another $200 each quarter. Every year, that amount would be raised by 2%. By 2011, the quarterly investments would be around $400 excluding the reinvested dividends. The total direct capital invested, excluding taxes, over the 35 year of this project would be less than $45,000. Today, the investor would have over 16,000 shares worth approximately $1.2 million. The following chart shows a more detailed build up over time:
Source: Yahoo!Finance for stock prices and dividends, author calculations. Figures are rounded to nearest thousand.
The three key aspects that drove the value of the portfolio were the appreciation of the initial investment, the appreciation of the shares from dividend reinvestment and the appreciation of shares from incremental share purchases. The incremental stock purchases (~$39k) were less than the dividends (~$61k) received from the initial investment. Consistent dividend investing in PEP has clearly paid off. Time is the best ally of a patient, disciplined investor.
Always remember that taxes matter
This strategy assumes no stock sales that would trigger capital gains. The initial investment created about $192k of capital gains, which corresponds to about $29k in taxes at the 15% long term rate. Later investments that have appreciated would also trigger capital gains. Furthermore, the investor would owe taxes on the dividends that have been reinvested. Applying a tax rate of 25% and then the favorable qualified dividend rate of 15% for more recent years, the investor would have owed just over $66k in taxes over the years. The following table details the cash out of pocket for the investor from 1977 to present:
|Initial Investment||$ 3.6|
|Recurring Investments||$ 39.2|
|Taxes on dividends||$ 66.3|
Source: Author calculations
The majority of the cash outlays were cash taxes on dividends. There are also additional liabilities from the unrealized capital gains. This portfolio, which produces over $33,000 in income each year, could be combined with other sources (social security, pensions) to allow the investor to possibly not have to liquidate any shares. In the end, the investor's heirs might receive a nice portfolio that has a stepped up cost basis. An investor could also leverage tax advantaged (e.g., Roth IRA) accounts to minimize the tax burden.
Assuming the investor started when they were 25, they would now be around 60. At this point it might make sense to diversify the investments. The easiest and most tax efficient way would be to direct dividends and other investment sums to other investments: bonds or cash. I would be hard pressed to suggest 100% equity portfolio to someone who is already in their 60s.
The initial investment of $3,600 is a large sum for 1977. I ran my model again to calculate the required quarterly investments to reach the same $1.2 million without any initial stock purchase. Instead of investing $200 every quarter, an investor would have had to invest $300 per quarter with the same 2% annual escalation. This approach should be more feasible. The key point is to simply get started.
The final point is that this worked well for PEP, raising the question of where would one find good dividend stocks today. I think there are a wide range of established dividend stocks including PEP, The Coca-Cola Company (KO), and Johnson and Johnson (JNJ). I'm sure readers will suggest their favorites. I would also suggest Intel Corp. (INTC) and Cisco Systems (CSCO). Despite shorter histories of paying dividends, they are industry leaders. Clearly there is no guarantee that any of these companies will deliver the necessary returns for the next 40 years, but a basket of some of these would be a reasonable bet. Most likely, one would also have to commit more capital over time to account for lower returns. In any case, you shouldn't be relying on a chimpanzee throwing dice if you're trying to save a million dollars.
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.