Returns on Compounding
It’s easy to lose sight of what those prices signify in a market fascinated with stock price movements: the value of owning a company’s future earnings potential. Dividends, which are cash or stock payments that represent a share of a business’s retained earnings, are one of the most common ways that firm earnings make their way into an investor’s wallet. The amount of earnings a firm has left over after paying dividends to its shareholders is known as retained earnings, which is listed under the shareholder’s equity section of the balance sheet. RE = BP + Net Income – Dividends, where BP = Retained Earnings at the start of the term.
Before we get into why dividends are important in the long run, consider the following graph, which shows how much of a difference reinvested dividends would make in a five-year holding of NASDAQ:FELE versus dividends held as cash and ordinary price appreciation.
Three values are plotted over a five-year period in the graph below:
1) The worth of a $100 investment in FELE, assuming no price increases.
2) Without reinvestment, the value of a $100 investment in FELE.
3) The value of a $100 FELE investment if dividends were reinvested promptly.
4) The value of a $100 NASDAQ:SPY investment if dividends were reinvested promptly.
What Effect Does a Dividend Have on a Stock’s Price?
It’s important to note that dividends will be declared with an ex-date. This is the deadline by which a shareholder must own a share in order to receive the dividend. Because new purchasers will not have the opportunity to receive the dividend, the effective value of each share may go down by the size of the dividend at the conclusion of trade on that day.
However, when the market reopens the next day, the stock price may rise above its previous close or continue to fall short of its previous value. This ambiguity stems from the broad market pressures that prevail on any given trading day. For example, the company’s industry could be trading up due to good news, entirely offsetting buyers’ lack of dividend rights…or, alternatively, the company’s industry could be trading down due to bad news.
Reinvested Dividend Value of Index ETFs vs. FELE’s
The graph above compares the performance of FELE’s reinvested dividends to those of the popular SPY and NASDAQ:QQQ ETFs (which track the components of the S&P 500, and NASDAQ 100, respectively, and pay out dividends for the underlying securities). The bars could not be lower than zero since a reinvested dividend is a fraction of a share of stock, and those shares cannot be lower than zero. Also, for FELE, SPY, and QQQ, the height of each bar shows the ultimate difference between the green and red lines on the first graph.
If one examines the price chart of FELE’s common stock, one can see that price appreciation alone misses out on a significant amount of value if one intends to own the stock for a long time. This is also true for other stocks; see all of Benzinga’s dividend data here (https://www.benzinga.com/calendar/dividends-ex) or in Benzinga Pro’s enhanced view./n
