Stocks are not something talked about in my generation of 20 something year olds. Many of my friends either don't know what stocks are (or how they work), don't believe it's worth their time to delve into them due a small return on investment ("ROI"), or it is perceived as throwing away money. This isn't to say that there aren't 20 and 30 year olds out there investing and well versed in the stock market - clearly we see some of the generation I am talking about right here on Seeking Alpha. However, I have noticed that it is not educated enough - or simply at all - in my generation to realize what buying stock in companies can do for one's future.
Considering the need for early education in stocks and the stock market, I believe that the best thing one can do for the generation of the future is to invest on their behalf and gift them shares. Through this practice it will allow the next generation to be active in their future and become educated in what is going to ultimately be theirs. Since financial security is a desire of most people it makes sense that this gifting will fuel the desire to understand the financial importance that stocks will have on their future.
I was fortunate enough to have a father and uncle who saw the value of investing in stocks. They wanted the same opportunity for me that they had to invest, and invest early in life at that. It's due to their willingness to gift me shares at birth, and those few years thereafter, which has allowed me to learn about those stocks and ask questions at a young adolescent age. Through them, I learned what the stock market even was, how it worked, what my shares meant and, probably most importantly, what a dividend was. I became active in my own future and didn't even realize just what that would mean.
When you are young and you have a birthday or a major event in your life that calls for celebration you typically expect child aged toys (in my case Legos or HotWheels) or some other kind of child appropriate gift. While I did expect this in my youth I wasn't always met with that offering. In fact, I remember one time my uncle handing me a box and inside of it was this nice looking piece of paper. I had to ask my dad what it was and he responded by telling me it was a stock certificate. I didn't understand, I thought, what am I supposed to do with this? In short the answer was simple; nothing.
Now it wasn't like these investments my relatives were making were some large sums of money. In fact some of the first stocks that were gifted to me were just two or three shares of a particular company. Over the course of these early years I was given stock in Walmart (NYSE:WMT), Merck (NYSE:MRK), Proctor and Gamble (NYSE:PG), Public Service Enterprise Group (NYSE:PEG), and Johnson Controls (NYSE:JCI). Honestly at that age I didn't even know what these companies were or what they did. However, the point was I didn't have to right away. I had many years to accumulate knowledge and understanding, both in what those companies did and how their profits benefited my portfolio.
Through these young years of mine I learned what a stock split was as well as what a dividend was and, more importantly, what to do with that dividend. By virtue of the accounts they were held in and the direct registration system ("DRS") that they were associated with, the dividends I received were put into a DRIP (Dividend Reinvestment Plan). This allowed the dividends to be put right back in the company and increase my share holdings by purchasing fractional shares with the dividend proceeds. It was all automatic and for many years I didn't even know it was occurring. These dividends as well as the capital appreciation that was happening through the growth of these companies were bringing my holdings further and further and all with only a few dollars at the start. The rest was simple - do nothing.
Fruits of the Labor, Or Lack of Labor
Now some investors might argue that the idea of holding and doing nothing is not a good approach because many things change over the years, especially for the 15-20 years I am talking about in this article. However, having gone through this with my personal portfolio and seeing the results I would contend that it is (and was) a good idea to do nothing for this time period. With strong companies such as the ones I mentioned above, there was no reason to shuffle holdings around every year or so. These companies were strong, dividend paying companies that had plenty of growth ahead of them.
This is not to say that as I became older and sat down with my father to look at what had happened in the portfolio for the previous 10 or so years that I didn't decide to add more to some companies and move out of others. I will illustrate further in this article just how and where that adding and moving came.
The point is that the buy and hold method for this type of situation is most likely the best and I feel strongly that it was for my situation. Fiddling with so few shares and doing anything different with the dividends would probably cause more harm than good. The 90's and early 2000's proved to be good years for these companies with the issuing of undisrupted dividends, the increase in dividends, and the share split events along the way.
Don't Mess With It Approach Results
Having explained the scenario as well as the benefits of what it means to instill knowledge in a young investor's portfolio and mind, it's time to see what came of that. In this article I will use one of my best performing companies in this time period: Johnson Controls.
JCI was first purchased for me in February of 1993. It amounted to $150, or 3.2 shares at a price of $46.88; very humble beginnings indeed. In case you are wondering this purchase is 22 years old and I had to find the original paperwork to know what the exact purchase price was as well as the initial invested amount. That year I also received $3.25 in dividends for a reinvested increase of .065 shares.
The first stock split I was a part of with JCI was on April 1, 1997. To that point I had 3.592 shares. It split to 7.184 and on that day my shares were worth $290.22. That would be a 93.48% increase from February of '93 with all dividends reinvested. For comparisons sake the S&P 500 rose 78.21% during the same time period. Let's also not confuse anything here; a stock split doesn't change the value of my holdings by a single penny. To me it only showed that management saw the growth in the company, and subsequently its stock, and was a bullish sign to me. A split essentially just allows the retail investor to buy larger lots at lower prices. In the 90's this may have been more pertinent because some brokers charged more for "odd lot" purchases rather than round lot purchases of 100 shares.
By millennium's end I had 7.495 shares worth $402.87 which equated to a 168.58% increase over the initial $150 investment. Keep in mind this is with all automatic DRIP and no involvement from anyone taking care of the portfolio. Just a let-it-ride approach is all that occurred here.
At this point in life I had a better understanding of the companies I had ownership in. If nothing else, I knew JCI was doing well for me and I liked the increased dividends that were being announced as well as the capital appreciation which kept leading to more splits. I wanted to invest more into it but I didn't want to fund it with new capital. Instead I decided to utilize my other investments given to me. Now at 2004, my JCI holdings had reached another 2 for 1 split on my then accumulated 8.027 shares which now gave me 16.054 shares. The holding was worth $936.50, an increase of 524.33%.
During this young timeframe of mine those other investments I began to mention were doing well, but it depends on what time frame is looked at. If we take the same time frame of February '93 to April '97 we see in the chart below that WMT, another investment of mine, hardly moved and was pretty range bound.
Source: Google Finance
However, after this time period Walmart began to take off but plateaued once more, being range bound for another set of years. The chart below outlines this increase and subsequent settling.
Source: Google Finance
If we compare Walmart to Johnson Controls for the '97-'07 years you see there was a difference in capital appreciation but a divergence in 2007. With this in mind, I finally decided to take these increases from my Walmart holdings, along with some other shuffling, and place it in my Johnson Controls holdings in 2007.
You might notice I decided to sell somewhat low (Walmart) and buy somewhat high (Johnson Controls). Obviously this is contrary to the buy low, sell high methodology that creates profits. This was a learning curve I was getting to understand; about market movements and timing. On the other hand, after many years of being invested, and barring any significant drop in any of the holdings, selling would return a nice profit regardless. At any rate, I was only using a portion of the Walmart holdings, some holdings in Merck, and a closed out position in AOL (NYSE:AOL) (which was originally initiated for me during the "dot com" era which made a little on it as it was on its way down).
Five shares of Walmart were sold to net me about $250 in proceeds, a couple hundred in cash of Merck and the same with AOL. This gave me about $850 that was then used to buy 7.5 shares of JCI just before its 3 for 1 split in 2007. Bringing it all together, before the purchase I had 16.932 shares worth $1,599.11 and after the purchase and split I had 73.296 shares worth $2,952.08. This increase in worth was largely due to the rapid increase in JCI's stock price during this time period of January 2007 to October of 2007 (as shown in the chart below).
This additional funding and split is what brought my Johnson Control holdings to its peak where I left it till very recently in 2014. At which time I moved these gifted holdings from the DRS to my stock broker account. At this point I could either sell this mature holding or purchase more very easily.
The total shares held came to 83 and was worth $4,050.40. This is an increase of 2,600% over the initial investment including the purchase in 2007. Obviously this isn't completely accurate if we want to find the organic growth from just the $150 initial investment so I went back and ran the numbers without the additional 2007 7.5 share purchase. I would have wound up with about 53.5 shares which in 2014 would have been worth $2,610.80. This equates to a true growth of 1,640.53% over 21 years or a 15.3% annual growth rate.
The key to this return was the reinvestment of dividends back into the companies I had, specifically JCI. Without this reinvestment I would not have compounded the few dollars in dividends per year. I believe that just initiating the investment alone and taking the dividends as cash would have not propelled the investment as much as it did with the dividends reinvested. Not only was the dividend increases given by the company a benefit, but I was able to increase the amount of cash I was given in dividends by reinvesting those same dividends back into the company. Said another way, I increased my own dividends by way of the dividends themselves through reinvestment. I think seeing this play out (on paper at the time) is pretty neat. There was a compounding effect of dividends pouring back into the portfolio by simply just saying "thank you" and "here you go."
The True Gift
The exercise I walked through above was to demonstrate just how valuable such a small investment can be when you have a good growing company, or companies, and time on your side. Just imagine what double that initial investment would mean or if you had the means to invest $1,000. In the latter case that matured investment would be worth $16,405.30 at the end of the exercise.
Over the course of those 21 years, that $150 was worth more than just a few thousand dollars. That $150 taught me the principles of the stock market, what it meant to invest and be patient, as well as how to manage money in a responsible way. The reason I have funds and investment money to work with is because of that investment, and some others, along with the knowledge of my father and uncle.
I plan on doing this same process for my future children as I have seen firsthand just how valuable this method is. And if time is on your side you can see a small beginning turn into a valuable and worthwhile pile of equity -- and knowledge.
Disclosure: The author is long JCI, WMT, PG, PEG, MRK. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.