If you’ve owned dividend paying stocks before you know the feeling.
The giddy moment you have when the company announces the pay date. You start to calculate how much cash you’re going to get this time around, or if you have the re-investment plan on you’ll calculate how many shares are going to be purchased for you.
But what about when a company reports a dividend increase, Should we be just as happy? Dam right we should be.
We just received a pay rise for being a shareholder. And, to top it off depending on the size of the increase our invested principal is beating inflation and gave us more purchasing power.
On the subject of dividends, I’ll just leave this quote here by John D Rockefeller “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”
Yes Johnny, I totally agree with you.
Dividends are paid out of cold hard cash, the affect of this means companies will only pay a dividend if they can afford it.
If they can’t afford it, they’ll usually push it a couple of years by taking on debt or issuing more stock to raise money (diluting your shareholding). But eventually the market will find these companies and punish their stock price for this behavior.
No company wants to cut their dividend.
The market doesn’t take it lightly when they do and those companies stock prices will get clobbered if they cut the dividend. They’re signalling to the market there’s trouble ahead and they need to tighten up their belt to get by.
To be honest, the market usually spots it coming a long way out. So those companies stock prices will usually start to get beaten up before they cut the dividend.
Since businesses will only pay dividends if they can afford it, then what about the increases? Well, for a company to raise its dividend they have to feel bright about the future and the earnings potential that’s about to come their way.
It’s a big deal when companies increase their dividend, because as you now know it doesn’t look good if they have to reduce it.
Companies can also increase their dividends thanks to inflation.
As the prices of goods and services rise and businesses incur those price increases they can pass on those same price increases to their customers. This in effect increases their earnings which can then be passed on to shareholders with dividend increases.
What happens when they increase the dividend?
A few things happen.
First, you’re now getting paid more for the shares you own. That’s right, when a company raises the dividend, they’re rewarding you the shareholder for simply owning the shares. I wish I received pay rises at my job that easily.
Second, your money is now beating inflation.
Ahhhh yes, inflation the silent killer of your money. Inflation reduces your purchasing power but dividend increases will increase your purchasing power by putting more money in your pocket.
And lastly, your initial dividend yield has just gone up (if you’re not sure what dividend yield is, then check out this post). Another term people will likely use is yield on cost. To get the full affects of this benefit, you’d want to be holding the stock for a long time before you start collecting that big dividend yield.
The math behind an increase
Alright, so you’re getting paid more for the shares you own. Here is how it works.
You owned 100 shares of company A and they pay a per share dividend of $2 each year. Your dividends for the year will be:
100 shares X $2 dividend per share= $200
The next year company A is feeling so generous they raise the dividend by 20%. The new dividend for the year is $2.40
100 shares x $2.40 dividend per share= $240.
Sure, it might not look like much only with on an extra $40 a year, but what if you owned 10,000 shares? That’s a $4000 pay rise.
The goal isn’t to own a small amount of shares, we should be looking to build a huge portfolio that can fully support us through dividend income.
This is very important, have you ever wondered why $1 was worth so much more 100 years ago?
Inflation is the increase in price of goods and services over time, for example a loaf of bread 100 years ago might have been 10 cents but it’s now worth $2.
Prices have risen, decreasing the value of money because you can now buy less for your money. Or another term for it is your purchasing power has decreased. It all Sounds confusing, I know. And it really deserves it’s own blog post so you can develop a better understanding.
When you receive a dividend increase, you’re now making more money on your original investment. Instead of you purchasing power decreasing your purchasing power has now increased.
Rising dividend yield (Yield on Cost)
This is where the holy grail kicks in for some people. And for other people this metric doesn’t mean anything. It’s completely up to you if you want to find value in it or not.
Yield on Cost, is the concept to measure what your yield is on your initial investment after there have been dividend increases. Continuing with the $2 dividend example above, we’ll get the math out again to help illustrate the point.
You purchased those 100 shares of Company A at a share price of $50 a share. Your starting dividend yield of 4% is calculated as:
($2/$50) x 100= 4%
Remember next year they raised the dividend so your new dividend yield is:
($2.40/$50) x 100= 4.8%
Your income and dividend yield have both increased, beautiful stuff.
Also remember, it doesn’t matter if the share price has gone up or down because we always calculate the dividend yield off what we paid and the dividend received.
An extreme example of dividend increases
One of the most famous outcomes for an investor and buying a company with consistent year over year dividend increases comes from everyone’s favorite investor Warren Buffet and an investment he made in 1988.
Back in 1988, Buffet bought just over $1 billion worth of Coca-Cola stock (NYSE: KO). In 2019 he received $640 million in dividends. Remember how to do the math? Some big numbers but we can round them down to get the same outcome.
($640 /$1000) x 100= 62%.
Buffets Yield on Cost or current dividend yield for this investment is 62% give or take some rounding errors… That’s some crazy stuff. 1 year and 6 months of dividend payouts and he’s paid for his initial investment.
That’s long term investing at its finest.
The wrap up
What do you think, are dividend increases important? Let me know in the comments below.