The Power of the Dividend

In a world obsessed with price movements of stocks, it's easy to lose sight of what those prices represent -- the value of holding a company's future profit potential. One of the key ways that profit potential turns into profit actualization in an investor's pocket is the dividend -- cash (usually) payments made to stockholders representing a portion of a company's retained earnings. Retained earnings is found under the shareholder's equity portion of the balance sheet and represents the amount of earnings a company has left over after paying dividends to its shareholders.

Retained earnings is calculated as:

RE = BP + Net Income - Dividends Where BP = Retained Earnings at the beginning of the period. Net Income = Revenue - Expenses

Before further discussion of why dividends can be impactful in the long-term, here's a plot showing how much of a difference reinvested dividends would make in one's five year holdings of NYSE:PNC compared to holding the dividends as cash and regular price appreciation.

The following plot shows three values over a five-year period: 1) The value of a $100 investment in PNC, with only price appreciation. 2) The value of a $100 investment in PNC, without re-investment. 3) The value of a $100 investment in PNC if dividends were immediately reinvested. 4) The value of a $100 investment in NASDAQ:SPY if dividends were immediately reinvested.

How Does a Dividend Impact a Stock's Price?

A key thing to note is that dividends will be announced with an ex-date. This ex-date is the date on which one must be a holder of a share in order to receive the share's dividend. At the close of trading on that day, the effective value of each share may go down by the size of the dividend, because new purchasers will not hold the right to receive the dividend.

However, by the time the market opens the next day, the stock price could rebound up beyond its previous close, or continue to lag after the dividend rights have been rewarded. This uncertainty is simply due to broader market forces that exist on any day of trading.

PNC's Reinvested Dividend Value Compared to That Of Index ETFs