Dividend Reinvestment: Should You Do It?

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Includes: GE, MSFT, PBI
by: Lynn Costlow

Summary

Some dividend growth investors struggle with the decision to reinvest dividends (or not).

For long-term investors, dividend reinvestment programs inherently focus on income, as opposed to price, by dollar cost averaging dividend reinvestment and compounding both share count and dividends.

To support your reinvestment decisions, I compare actual DRIP vs. no-DRIP cases showing how reinvestment performed in three radically different examples: Microsoft, General Electric and Pitney Bowes.

Update 03/27/17 3:57 PM: We have updated this article to accurately reflect GE's dividend history. We removed mentions of dividend cuts in 1997 and 2000.

Speculation vs. Investment

I believe it is important that stock market participants understand the distinction between "speculation" and "investment." Investopedia provides a succinct definition of "speculation":

The act of trading in an asset, or conducting a financial transaction, that has a significant risk of losing most or all of the initial outlay, in expectation of substantial gain.

I firmly believe the lure of "substantial gain" entraps speculators into abnormally risky activity.

In contrast, Warren Buffett provided a definition of "investment" in his 2011 annual letter to Berkshire Hathaway shareholders. He clearly identifies that his concept involves buying a growing asset that produces something that people want. Here is an excerpt:

My own preference … investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment.

For another definition of "investment," Value Line provided an excellent one a few years ago:

... the old way was easy to tell. An investment is something that pays you. So is real estate an investment? It can be. If you purchase a house or a building and rent it out, the answer is yes. ... So are stocks an investment? They can be. But again, only if they pay you. And the only real way a company can directly pay you is through dividends.

In the stock market, achieving success with speculation is largely at the mercy of thousands of (possibly schizophrenic) players and what they do (or don't do) with a particular stock price in the market. Can anyone reliably predict what the actions of others will be? For reliability, I firmly favor dividend growth investing. I enjoy watching dividends consistently arrive, and I especially enjoy watching them compound with reinvestment and growing rates.

Turning the Psychology Upside Down

Stock market investors who favor dividend income have one thing in common with many speculators: Both prefer a low purchase price that likely will not decline but rather will rise after acquisition. For dividend investors, the amount of income is determined by the yield, defined as current annual dividend per share divided by current stock price per share.

Most market participants logically and psychologically desire to see their holding value increase, but this adversely affects yield of next purchase (by either new capital or dividend reinvestment). Income investors naturally want the highest income per dollar invested (a higher yield). Since yield rises with lower price, income investors favor "buying low." Therefore, at initial purchase, both speculators and income investors have one perfectly aligned mutual goal: buy low.

However, after a purchase, a stock's price behavior may or may not benefit the owner based on other factors. For one, if the owner bought the stock for income, he/she is not looking to sell the stock at a large capital gain and "make a killing." So the desire for a higher price may not be overly important, if at all. Investing for income is inherently a long-term activity simply because "income" generally involves payments received periodically over time.

Therefore, "income" typically involves ownership for years or even decades. It's inherently an open-ended concept. Dividends from high-quality companies are also open-ended and hopefully go on "forever."

Regardless of price behavior, if the owner retains the stock with no sale, any price movement is only a "paper" gain or loss. Consequently, there are no tangible consequences except one: The dividend income stream continues unabated, meeting the income investor's primary objective.

Growing Assets from the Couch

"Remember that money is of a prolific generating nature. Money can beget money, and its offspring can beget more." -- Benjamin Franklin

Once a dividend-paying stock is acquired, the investor faces a decision to keep the dividends or to reinvest them in the same stock. Reinvesting dividends generates multiple favorable benefits. First, regular reinvestment (typically quarterly) not only buys more shares of stock, it involves "dollar cost averaging" (DCA). Low share prices increase the number of shares purchased, and high share prices reduce the number of shares purchased. This self-regulating feature inherently reduces average purchase price per share over time. For a given dividend rate, DCA results in more shares acquired as price fluctuates.

Second, when the dividend-paying company raises its dividend rate (typically annually for most high-quality companies), reinvestment buys an even higher number of shares.

Third, since both of the benefits above result in more shares owned, future dividends will be even higher. This third benefit directly employs the concept of compound interest.

Compound interest is interest paid on interest, in addition to interest paid on original principal. Your money earns money and your money's earnings earn money. Compound interest is a simple and effective way to legitimately build a nest egg. The trick is you need to leave the money alone and let compounding work its magic. In other words, you must have the discipline to "sit on your couch." In a typical bank savings account or CD, the interest rate is fixed. But in dividend reinvestment, "interest rate" resembles "dividend rate," which may increase annually. So dividend reinvestment compounding provides an extra kick compared to fixed interest rate.

Fourth (and finally), the higher number of shares acquired increases the asset value of the holding. This should greatly appeal to income investors who also desire higher total return.

All four of these benefits occur automatically with no new capital while "sitting on the couch."

To DRIP or not to DRIP

With time, compounding of reinvested dividends begins to significantly grow the share count, which in turn grows dividends and asset value. The underlying principal of compound interest forms a "snowball." While the investor does nothing, compounding silently works its magic.

The investor obviously could choose to use dividend payments for some other purpose, such as buying stocks in other companies. Many investors follow this path. They correctly cite that they avoid high reinvestment purchase prices by finding better values. They also achieve more diversification. For many, this is a totally acceptable and profitable approach.

But quantitatively comparing the two approaches (reinvesting vs. not reinvesting) is impossible. The primary reason is the unknown performance results of dividends not reinvested but put to other use. All I can do is list the pros and cons of each approach:

Pros of not reinvesting:

  1. More diversification, if you buy other stocks
  2. Potentially higher total return and asset value, if you buy other stocks
  3. Building cash reserves, if you don't buy other stocks
  4. More spending income, if you don't buy other stocks or build cash

Cons of not reinvesting:

  1. Time delay before buying other stocks to accumulate enough dividends to avoid big fees
  2. More transaction fees to buy other stocks
  3. More due diligence effort to identify next stock purchase
  4. No fractional share purchase ability

Pros of reinvesting:

  1. Added shares create higher future dividends
  2. Added shares boost asset value and total return
  3. Automatic reinvestment requires no effort after setup
  4. Brokerages typically charge zero transaction fees for reinvestment
  5. Every penny put to work and compounds since small dividends can purchase fractional shares
  6. Dividend money goes to work without delay to increase the next dividend
  7. DCA lowers average reinvestment purchase price per share

Cons of reinvesting:

  1. Some purchases may occur at elevated prices
  2. Existing stock may be a poor investment compared to alternatives
  3. Adds no diversification

Hopefully, readers see that a quantitative comparison between the two dividend approaches is not achievable. One must look in the "rear view mirror" to do a specific comparison, but by then, it's too late. So it's a judgment call. As you might suspect, I favor the dividend reinvestment approach and I use it in my E*TRADE account with the automatic DRIP option. I believe the following results illustrate why this is a good choice.

DRIP and No-DRIP Performance Examples

I offer three actual examples of investments I made (and still hold) before the 2008-09 Financial Crisis to highlight how dividend reinvestment with DRIP has provided more shares, more dividends, and higher asset value (in two cases) compared to not reinvesting dividends. While I still continue to learn about investing, all three investments discussed here were made before I knew nearly as much as I do now about how to pick high-quality dividend growth stocks with good values. Consequently, the three examples cover three radically different investing experiences:

  • Microsoft (NASDAQ:MSFT), high growth price / dividend grower
  • General Electric (NYSE:GE), dead money price / dividend slasher
  • Pitney Bowes (NYSE:PBI), collapsed price / dividend cutter

Microsoft

I bought three blocks of MSFT shares:

Date / Shares / Price Per Share

10-28-03 / 200 / $26.90

01-18-05 / 100 / $26.00

06-05-06 / 100 / $22.71

MSFT didn't begin paying regular quarterly dividends until 09-14-04. Shortly after that, the company paid its famous gigantic one-time $3.00 per share special dividend on 12-02-04. That payout totaled $600 based on the 200 shares I owned at the time. Unfortunately, I had not activated DRIP before that big payout! Later, in early 2006, I decided to activate DRIP, causing the first reinvested dividend to occur on 06-08-06. The company raised its quarterly dividend rate from $0.08 in late 2004 to $0.39 in late 2016. Those numbers multiplied the dividend almost five-fold over only 12 years at an impressive 14.1% compound annual growth rate (CAGR) - not bad for a new dividend payer.

To date, MSFT has paid me $4,725.60 in dividends, including $600 from the 2004 special dividend. Those dividends represent 46% of my original investment cost of $10,251. If I had not reinvested, I would have collected only $3,590.00 in dividends for use elsewhere. The DRIP dividends are 31.6% more than the no-DRIP dividends.

With that background, I offer these graphical depictions of how this former no-dividend high growth stock with a newly instituted and maturing dividend commitment has performed. Charts show results both with and without DRIP.

The MSFT price in the chart below has multiplied a little more than two-fold during the holding period. However, it languished in the doldrums for a decade until 2013-14, when a 100% rise commenced. The rise roughly corresponds to the reign of the new CEO Satya Nadella.

Source: E*TRADE

The asset value chart below depicts the hypothetical asset value of the original stock assuming no dividends, the hypothetical value of original stock without reinvestment plus cash dividends and the actual asset value with dividend reinvestment. MSFT paid minimal dividends in the early years, so the impact on asset value is minimal. However, reinvesting dividends clearly creates a faster rising asset value and that trend continues to snowball.

The asset value with DRIP is 28.5% more than the hypothetical value of no dividend and 12.2% more than asset value without DRIP plus cash dividend. The share count with DRIP now totals 516.9 compared to the original purchase of 400 shares.

Source: Created by author

The MSFT dividend chart below reveals how dividends compound with DRIP to provide an ever-increasing dividend payout each quarter. The $600 special one-time dividend in 2004 is clearly "off the chart." Notice how the dividend curve without DRIP has four data points at the same level followed by an increase only at annual dividend rate increases. However, the curve for the DRIP case shows every single data point higher than its predecessor due to higher share count. I find that extremely gratifying.

The last 2016 dividend with DRIP was $199.13 and exceeds the $156.00 dividend without DRIP case by 27.6%. That difference grows larger with every single dividend. Current yield is 2.4%.

Source: Created by author

General Electric

In reading many Seeking Alpha articles on GE, I have seen tremendous animosity, primarily in comments, brought on by that company's poor performance due to its huge deviation from its industrial roots into financial businesses tied into the mortgage shenanigans. Those businesses almost brought the giant to its knees during the 2008-09 Financial Crisis, which affected many huge mortgage-related financial entities.

Rectifying the problems has taken the entire time since the Crisis. Investors suffered a 68% quarterly dividend cut from $0.31 to $0.10 in June 2009. GE has recovered the dividend to only $0.24 as of this month. The company divested its financial businesses to a level that allowed it to successfully shed the SIFI (systemically important financial institution) government-imposed classification in June 2016. The company has now finally escaped the onerous regulations imposed on SIFI-designated companies after the Crisis. And it has largely returned to its roots as a diversified industrial business.

In 2006, at the time of the first three of the four GE purchases I made (for 91% of shares), I had no idea how deeply GE's financial businesses would be affected by the mortgage shenanigans. If I had known, I still wouldn't have had any idea that the entire mortgage-related world would subsequently "blow up" and become the Financial Crisis of 2008-09. I know I'm not alone. But there's no substitute for doing one's homework. Ignorance is not bliss.

Source: E*TRADE

I bought four blocks of GE shares. The stock price chart is a poster child for the "doldrums" or "dead money." On 03-16-17, GE closed at $29.88. GE has yet to recover to $32.43, which is the average price I paid for the total holding. And, after a full decade, it remains way below its 2007 peak of $40(+).

Date / Shares / Price Per Share

05-31-06 / 100 / $34.17

07-07-06 / 100 / $33.30

08-08-06 / 100 / $32.25

08-19-13 / 29 / $23.90

I began receiving dividends in July 2006 right after the first purchase. And I activated DRIP in time to catch the dividend on 10-25-06 right after the third purchase. It remains activated.

The total cost of shares was $10,665.10 excluding fees. The asset values at 12-31-16 were:

$10,396 hypothetical value of 329 original shares without dividends

$13,163 hypothetical value of 329 original shares plus cash dividends

$14,710 actual value of 469.2 original plus DRIP shares

The last value above represents a 37.9% total return on the original cost. In reality, considering inflation, it's barely breakeven, given the time period of almost a decade. But without the dividends and reinvestment, the total return would have been a negative $269.10.

Source: Created by author

From another aspect, E*TRADE indicates my total average cost is a little lower at $29.77 as of 03-16-17. This number includes the collective cost of all shares procured by both original purchase and by DRIP. Based on that number, dividend reinvestment has lowered my total average cost below the original purchase cost of $32.43 - a good thing.

To date, GE has paid me $3,216.23 in dividends. The amount represents 30% of my original investment cost. The chart below shows my GE quarterly dividend payouts over time.

Source: Created by author

The good news is that dividend payouts are climbing due to DRIP compounding the last two years despite no rate raise. Hopefully, the company soon begins a regular dividend rate increase every year. Current dividend yield is 2.95%. Thousands of skeptics are waiting to be convinced the restructuring will succeed.

Pitney Bowes

I purchased 100 shares of PBI on 06-12-06 for $40.60 a share. I was attracted to its juicy and rising dividend. But I obviously overlooked the long-term secular decline of its postal equipment business (ever heard of email or the Internet?) and the huge debt load carried by the company. As of 03-16-17, PBI closed at $12.84.

Source: E*TRADE

I followed the company for several years and enjoyed its dividends. But I became more and more concerned as I learned more. I activated DRIP immediately after purchase, but turned it off in calendar year 2012 out of concern I was pouring money into a black hole. In calendar 2013, I re-activated DRIP, because the company began taking action to remedy its problems with a new CEO hired in December 2012. DRIP remains active today. PBI cut its quarterly dividend 50% in June 2013 from $0.375 to $0.1875 as part of its emphasis to pay down debt. The dividend remains at $0.1875 today as the company reinvents itself under the new CEO.

The asset value with DRIP shown below is actually somewhat lower than the asset value without DRIP plus cash dividends. This unusual situation is due to a really depressed stock price, coupled with cash values that don't shrink (ignoring inflation). If/when the stock price recovers, I expect the value with DRIP to surpass the asset value plus cash dividend.

The original purchase of 100 shares has now increased to 159.3 shares with dividend reinvestment. Share count continues to grow even faster with the depressed price.

Source: Created by author

My PBI purchase was very modest. Therefore, when PBI ran into trouble, I decided to not sell it at a loss. I have an interest (no doubt to some, a perverse interest) in watching how management attempts to turn around troubled companies. PBI's basic problem was (and is) a secular shrinking core business coupled with excessive debt. I believe (perhaps naively) that good management can solve these issues. So I elected to hold and watch it as an experiment to see if the new CEO could turn it around.

To date, PBI had paid me $1,532.82 in dividends. That represents 38% of my original investment cost. Of that amount, all but $200.04 (from the 2012 DRIP "turnoff") was reinvested.

Since the 50% dividend cut in 2013, no dividend rate increases have occurred as management attempts to reinvent the company. Given the situation, this is probably the right approach. The temptation to "cut bait" is strong, but I remain a holder so far. One reason is that, despite the dividend cut, the yield on 03-22-17 is a juicy 5.95%.

Another reason is that, with the high yield, the dividend payout is climbing fairly rapidly due to DRIP acquiring more shares. This is the beauty of low prices causing DCA action coupled with high yield to acquire more shares. The bad news is PBI's poor turn-around results so far and the resultant market punishment of the price (collapse to $12.49 on 03-22-17). But the good news is that compounding works even better in this sad situation.

Source: Created by author

Conclusions

I offer these takeaways from my experiences with these three dividend stocks:

  • Management matters - a lot. All three companies demonstrate this fundamental reality.
  • Dividends help compensate for a host of problems.
  • DRIP is easy, automatic and generally boosts both income and total return.
  • DCA helps by achieving lower average purchase cost per share.
  • Stock selection due diligence is extremely important.
  • Stagnant or collapsed price raises dividend yield, which boosts DRIP compounding.
  • Selling after a dividend cut (I didn't) will almost always guarantee a capital loss.

In the future, I believe MSFT will reliably continue to grow its dividend rate. And I hope the ongoing turnarounds at GE and PBI succeed. I will continue DRIP with all three stocks, since I have plenty of diversification elsewhere and don't currently need the spending income.

I solicit reader comments, pro and con, on your dividend reinvestment views. What factors influence your reinvestment decisions?

Disclosure: I am/we are long MSFT, GE, PBI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.