I got dividend investing all wrong. I looked at different styles of investing. I put aside dividend investing as something to look at later when I’ve retired and need to take income from the dividends.
There appears to be two types of dividend share (at the extremes of the spectrum): steady companies with low dividends of mostly less than 4% or distressed companies offering good dividends. For the former it looked like the non-dividend shares would give a better return. For high dividend stocks may appeared to be a ‘falling knife’.
What I had missed was this. If you find a sound steadily growing business paying a reasonable dividend the later dividends are paying out a much higher percentage if the amount is considered against your original cost basis. This means that if you invest in a good dividend company, one that has a record of dividend and share price growth the dividend percentage actually received in later years will be considerably higher than the headline figure for the year.
As an example I modelled a share held for 10 years with an annual growth of 5% in share price and a dividend of 3%. With no dividend reinvestment a £1,000 investment would become £1,551, so the dividend would be equivalent to 4.5% of the original investment. With the dividend at 3% reinvested every year the Investment becomes worth £1,990, so at that point the annual dividend payout is almost 6% of the original investment. If that is continued for a further 10 years the numbers double again giving an investment worth £3,996 and an annual dividend payment at 12% of the original sum.
Through playing with the model I discovered that a reinvested dividend share when you add the dividend of 3% to an anticipated growth of 5%, it is the equivalent to a ‘growth’ stock anticipated to grow at a 8% per annum.
So in assessing a share to investing, if you assume a reinvestment of the dividend it can be considered as the equivalent of a guaranteed addition growth at that percentage.
So I will no longer discount an investment, because its a dividend stock, I will asses it along side other opportunities on the basis of the likely total return.