Excess Returns

and finance Allah shmoop What is the math of dividend

reinvestment All right people While some stocks pay dividends you

know a bit of cash and investors get for holding

the stock It's little incentive Teo you know keep holding

onto the shares You could take that cash into whatever

you want with it but you can also reinvest it

which means buying mawr of the stock you already own

So the concept may seem boring but it's good way

to increase your stock holdings And it's like your shares

or having little baby shares all without you putting MOHR

of your own money into the process We'LL stock prices

move around a lot and as such the math behind

dividend reinvestment can get complex ish or well sometimes just

plain ugly So let's do a problem here You buy

thousand shares of Alpaca Corp and Alternative milk provider right

They provide milk from alpacas of course but also lamas

goats and yaks Well here's the stock performance over the

two years or eight quarters that you held the stock

A quarter is a three month period by the way

At the end of the first quarter the stock was

at one o two fifty then at the end of

Que Tu shares have risen a one o five and

stock kept going up in Q three reaching one of

seven five by the end of period Still climbing in

queue for alpaca reached one ten by the end of

that year Right next year Same basic story of stock

reach one twenty share after the end of the second

year and that's its performance The stock continue to pay

its fifty cent per share each quarter in Dividend Doe

It held the dividend steady for the full two years

so each quarter the company's sends you cash of fifty

cents per share for each of your thousand shares are

five hundred bucks each quarter You can choose to reinvest

that dividend each quarter The amount of stock that those

dividend repurchase sings by with that five hundred box Well

it depends on the stock price of time Right when

you got the first dividend payment while shares were at

one o two fifty five hundred divided by one or

two fifty share and that's about four point eight shares

So after this dividend reinvestment you have one thousand four

point eight ish shares And yes you can have point

eight of a share or something That's how the world

works OK under the second quarter you get another fifty

cent dividend per share in the stocks out one o

five Well remember you no longer have a thousand shares

You have a thousand four point eight shares because of

that dividend reinvestment thing in the first quarter So this

time around you get five hundred two dollars forty ish

sense in dividends Reinvest those dividends and while you get

another approximately four point eight shares something like that may

be a little more The process continues As long as

you keep the dividend reinvestment going you buy shares with

the dividends giving you Mohr shares which then increases your

dividend which gives you more money to buy more shares

Well the main complicating factor in this calculation is that

the price of the stock keeps moving It makes it

difficult to have a clear formula for how many shares

you get for some set amount of dividend payment right

You have to just do the math a quarter at

a time So what's the advantage to all this But

why reinvest instead of just taking cash simplifying our example

of it You're getting about five shares a quarter for

eight quarters in reinvesting your dividends So at the end

of two years you have forty more shares of alpaca

instead of having kept the cash dividend on your own

But say you just kept the cash well on a

thousand shares at fifty cents a share each quarter over

eight quarters That's four grand Also you still have the

thousand shares of stock that you owned originally now worth

one hundred twenty bucks each or one hundred twenty grand

Add in the four in dividends and you've got one

hundred twenty four grand See how that works That's the

map But here with dividend reinvestment and ignoring all kinds

of taxes and commissions and other you know realistic noise

well you'd have a thousand forty shares at one hundred

twenty dollars each for a total value of one hundred

twenty four thousand eight hundred bucks and change You'd have

made another eight hundred ish dollars by reinvesting your dividend

and this presumes that you spent all of the cash

dividends out to you when you didn't buy back shares

Ravan reinvesting that cash somewhere you know useful So why

does all this matter Well the S and P five

hundred pays about a two percent dividend in the modern

era Maybe three That is The median company pays about

that amount The SNP is Justin Index It rolls up

each of those five hundred companies into a single tracking

device Some pay a lot Maurin Dividend wanting some pay

a lot less some pain Nothing Hi Google Hi Amazon

Hi Facebook We're looking at you non dividend payers anyway

Since markets go up over time dividend reinvestment has made

relative returns better for those buying Mohr shares with their

dividends However it usually takes a long time for those

differences to really show up in total value or returns

And all of this is dependent on stock's going up

which doesn't always happen tends to happen in the long

run But in short first well who knows also tends

to work on an average here Yes and P five

hundred tends to trend upward over the long haul meaning

that out of five hundred major companies you can expect

the median one to show stock gains of about eight

nine ten percent year over time But in that group

while some stocks go down some go away Well if

you're a dividend reinvesting in one stock you return then

depends on what that one stock did Alpaca is going

up now because fru fru types like to stock their

fridges with yak milk But what if Yu Lan musk

develops a cheap lab created chemical alternative Teo yak milk

You know the bottom line dropout of alpaca dot com

And then you might wish you'd taken the cash and

not reinvested dividends Yakety yak as they say or you 00:05:11.895 --> [endTime] know something like that Ah