Oil magnate John D. Rockefeller, president of Standard Oil Company, was one of the richest people of all time. That oil company was forcibly split into six different companies. ExxonMobil, BP, Chevron, Gulf Oil and Texaco, among others, emerged from this.
The famous text from Rockefeller is: ‘Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.’ This made him not only the founder of the major oil companies, but also a pioneer in dividend investing.
Another historical great, the physicist Albert Einstein, once answered the question of what he considered the eighth wonder of the world. His answer was: compound interest, better known as the interest-on-interest effect. If investors do not withdraw their dividend income from the portfolio, returns can also be made on the previous return. In the longer term, dividends provide a surprisingly large share of total capital growth. It can easily account for half of the total return.
The eighth wonder of the world
The power of dividend yield becomes more apparent when the annual distribution is reinvested. Suppose an investor invests €1,000 in shares and receives a 4% dividend annually. If he or she withdraws the dividend paid every year from the investment portfolio, the return after 20 years is €1,000 plus 20 times €40. The proceeds are €1,800. If the dividend is not withdrawn from the portfolio but reinvested annually, the original investment will grow to €2,191. That’s €391 more.
As time goes by, the impact of reinvested dividends increases. Suppose an investor had invested $1,000 in the Dow Jones index 100 years ago. That was the only existing index at the time. After a century, the original investment would have grown to $370,000.
That seems nice, but if the dividend paid out every year had been reinvested, the result would have been $ 2,713,000, more than seven times as much! In those 100 years, the contribution of price gains to his total return was just under 14%. The remaining 86% was the result of the continuously reinvested dividends.
Yield on cost
Another phenomenon of dividend investing concerns the Yield On Cost (YOC). The YOC is the dividend yield on the initial investment. Suppose an investor buys a share for $10. A dividend of €0.50 is received on this. Earnings per share amounted to €1. The company has a dividend payout ratio of 50%. This means that half of the profit is distributed to the shareholders. Now earnings per share are growing by 10% every year.
So after 10 years the profit per share is €2.59. The company has managed to keep the payout ratio at 50%. The dividend therefore amounts to €1.30 per share after ten years. However, the YOC after 10 years is 13%!
87% dividend yield
When it concerns a share of a company that has managed to maintain its market position for decades or longer, it will ultimately cost quite a bit. After 30 years, the dividend yield has risen to over 87%. And that comes in every year without having to do anything for it! This is how Warren Buffett amassed most of his wealth. Not by constantly getting in and out, but by staying seated.
However, the condition is that they are companies with a long-term advantage over competitors. These are companies with a strong brand and a large market share. This gives them the power to increase prices without affecting sales volume. They can thus grow profits and dividends in good and bad times.
In their hunt for dividends, investors should not be guided by companies that pay out the highest possible dividend. A high dividend can be a signal that a company is in trouble. The dividend is high because, for example, the shares have fallen in price due to financial problems or other difficulties. The high dividend will probably not be maintained.
In contrast, companies that strike a healthy balance between dividend payments and profitable investments perform better. These Dividend Aristocrats typically have dividend yields of 2 to 5%.
A Dividend Aristocrat is a company that has been able to increase its dividend continuously for the past 25 years. It says something about the quality of such a company. An example is Johnson & Johnson. Even more impressive are companies that have been able to continuously increase their dividends for more than 50 years. Those are the Dividend Kings. Examples of this are Procter & Gamble and Coca Cola.
Taking advantage of the interest-on-interest effect can lead to huge returns over time. And you don’t have to do much for it.
Martine Hafkamp is general manager of Fintessa Vermogensbeheer. Fintessa is an independent, independent and specialized asset management office from Baarn, and a two-time winner of the Golden Bull. This publication has been compiled by Fintessa BV. The information contained in this publication is derived from sources and publicly known information that Fintessa BV considers reliable. This publication contains investment recommendations, but not investment advice or an offer or invitation to buy or sell any financial instrument. Fintessa BV cannot guarantee the accuracy and completeness of the stated facts, data, opinions, expectations and outcomes. Fintessa BV is an investment company and is licensed under the Financial Supervision Act. Fintessa BV is supervised by the Netherlands Authority for the Financial Markets and De Nederlandsche Bank. For the extensive Disclaimer, we refer to our website www.fintessa.nl.