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 earnings potential. One of the key ways that company earnings find their way into an investor's pocket is through dividends, which are cash or stock payments that represent 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.
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:HPQ 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 HPQ, with only price appreciation. 2) The value of a $100 investment in HPQ, without re-investment. 3) The value of a $100 investment in HPQ 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?
Dividends will be announced with an ex-date. This is the date by which one must hold a share in order to receive the dividend. Right when trading closes on that day, the market price of each share is expected to drop by the size of the dividend, because anyone now purchasing the stock will not receive the dividend.
That said, once the market opens the next day, the stock price could rebound up beyond its previous close, or continue to lag behind its prior value. This uncertainty is simply due to general market forces that exist on any day of trading. For instance, the company's industry may be trading up due to some sort of positive news, completely offsetting buyers' lack of dividend rights...or, conversely, the company's industry may be trading down due to some sort of negative news.
Index ETFs' Reinvested Dividend Value Compared to HPQ's
The plot above shows the evolution of HPQ's reinvested dividends compared to those for the popular SPDR S&P 500 ETF Trust SPY and Invesco QQQ Trust QQQ ETFs (which track the components of the S&P 500, and NASDAQ 100, respectively, and pay out dividends for the underlying securities). Note that the bars could not be below zero, as a reinvested dividend represents a fraction of a share of a company, and those shares cannot go below zero. Note, too, that the height of each bar for HPQ, SPY, and QQQ represents the final difference between the green and red lines on graph number 1.
Finally -- what's the point of all this? The key insight to take from this article is to note how much value simply looking at the price chart of HPQ's common stock misses if one's considering holding the stock for a long period of time. Dividends surely can matter.
© 2022 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.
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