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Dividends reduce your investment price and hedge your risks

   

Imagine that you had the foresight to put $25,000 to work in Realty Income (O) in December 2004, after it became a dividend achiever. Over the next decade, the company keeps expanding, and grows the monthly dividend payments to its loyal shareholders from 10.9375 cents per share to 18.21667 cents per share. As a result, you collect $15,000 in dividends over the next ten years. You have a few choices to deal with that cash:

A. Reinvest it back into Realty Income Stock
B. Reinvest it into another income generating stock
C. Save it in the bank for a rainy day
D. Spend it

Now, if Realty Income went bankrupt tomorrow (absolute worst case scenario), you would still have something of value, if you chose options B and C. Under all scenarios however, the dividends you received from the asset covered a large portion of the price you paid. This shows that a company that pays you a growing dividend over time, fueled by the improving business fundamentals, and purchased at attractive valuation, can pay for itself in less than a couple of decades.

In essence, the dividend checks you receive every month or quarter or year, act as a sort of rebate, that essentially reduces the amount you have invested and have put at risk. Therefore, if you bought Realty Income at a split-adjusted $25 per share in December 2004, and you manage to collect $25 in dividends over the next 10 – 15 years, you have essentially recovered your whole total investment.

However, in the case of a Realty Income investment in 2004, you would still own your stock and you would have a higher claim on dividend checks, simply because the future is more than ten years long. Even if Realty Income never pays more than $2 per share for the next 40 years, you would make several times your initial investment amount. Therefore, your risk was only $25, and was limited. But your reward was unlimited.

It is also important to not forget that a $1 today is worth more than a $1 from 2033, due to the eroding power of inflation. However, if that dividend at least keeps up with inflation or is reinvested in other income producing assets, chances are that each dollar would multiply exponentially over time.

For example, if you purchased shares of Eastman Kodak (EKDKQ) in 1983 for $1000, and you used the dividend checks to put in the bank or invest in other companies, you would be ahead of the game. This is because you would have collected dividends for 25 years in a row, and would have been able to put this money to work for you.

The stock traded at a split-adjusted $33.83 per share in 1983, but paid a total of $37.28 in dividends for every share through 2008. In addition, you received shares in Eastman Chemical (EMN) in 1994, due to a spin-off from Kodak.

The important thing to take away from this exercise is that you should not merely focus on stock prices themselves, as they do not show the whole picture of your investment returns. Even if the stock you hold drops by 50% after purchase and stays there, or even if the stock price fluctuates manically each year, you should not care, as long as you keep collecting those dividend checks.

I usually accumulate all my dividend checks in cash, and add them to the contributions I make to my dividend portfolio. After that, I allocate the cash in the best valued quality dividend stocks I could find at the moment. So far I have always been able to find something to put my money in, but if I was short of ideas, I would simply keep the money in cash.

Full Disclosure: Long O


Article printed from InvestorPlace Media, http://investorplace.com/2013/12/dividends-dividend-stocks-emn-o/.

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