Optimize your dividend investing for better profits over the long term.

We have often suggested that building a portfolio of dividend paying stocks may make more sense over a “growth” portfolio because the income can help offset some market volatility and price declines over the long term. Traders will often struggle with this concept because so much of their information is gathered from stock charts.

Video Analysis: Turbo-Charge Your Dividend Investing

Stock charts are tricky sources of information. Usually they reflect the payment of dividends (dividend adjusted) but sometimes they don’t. Additionally, not all data feeds and calculations are created equal so long term price charts can vary significantly depending on the source.

However, if a chart is dividend adjusted and the data used is reliable then it should reduce historical prices each time a dividend is paid so that there aren’t large gaps when a payment is made.

A dividend adjusted chart for a stock that has been paying consistent dividends over time will have very low historical prices because it has been adjusted many times.

For example, you can see a quarterly chart of Johnson and Johnson (JNJ) below with historical prices near $4 in the mid 1980’s. The actual price of JNJ in the mid 1980s was actually nearly $50 per share. You should also note that historical charts are also adjusted for stock splits.

Quarterly Chart for JNJ

When adjusting for dividends and splits, the compounded annual growth rate for JNJ is %12.4 over the last 20 years (including the 2008-2009 recession), which sounds pretty good but is only part of the potential return story. What dividend adjusted stock charts do not show is the impact of compounding the dividends themselves. The adjusted stock charts merely adjust the historical basis each time a dividend is paid.

The power of compounding your dividends is easy to underestimate when looking at historical stock charts. To illustrate our point consider a calculation you could do within a simple spreadsheet to compare the power of a stock paying a dividend that is taken as income versus a dividend that is reinvested (compounded) back into the same stock.

For our comparison we will assume that a given stock returns 6% per year in price growth and yields a 3.5% dividend. The two cases will contrast the returns of these two investment strategies over 30 years.

Case #1 – Taking the dividend as income
– $10,000 originally invested
– $29,330 total dividend payments
– $47,434 in profits from the value of the stock held
– Total return = $76,764 or 7.47% annual compound return

Case #2 – Reinvesting (compounding) the dividends
– $10,000 originally invested
– $57,773 total dividend payments (all reinvested)
– $145,756 in profits from the value of the stock held
– Total return = $145,756 or 9.34% annual compound return

What makes the difference between these two case studies? Case #2 outperforms because each time a dividend was paid new stock was purchased. More stock equals more dividends which are then reinvested and more stock is again acquired. Conversely, case #1 assumed that the dividends are taken as income, which is essentially what a dividend adjusted stock chart will show.

Dividend reinvestment can be done automatically through your broker or transfer agent and is available for funds, ETFs and even individual stocks. It changes long term performance significantly and when done within a tax-sheltered account, it can make a very material difference in your long term gains.