Dividend Reinvestment

Dividend reinvestment – British American Tobacco an example

If you want to build wealth with dividend paying companies, rather than generating an income right away, you should consider reinvesting your dividends.

Using your dividends to buy more shares – with those shares producing more dividends – to buy more shares, and so on, and so forth, you will take advantage of the ‘compounding effect’.

Once set on ‘automatic’ shares are bought even if you are ‘dead scared’ by what is happening in the markets, the wider economy, inflation, your salary, etc.

Let me show you how . . .

British American Tobacco – a perfect example

As I mentioned, if you are an investor who is not depended on dividend income right now you should consider using your dividends to buy more shares in the same or similar solid dividend paying companies.

Instead of cashing-in your dividends, you buy more shares in the same company, which leads to ever larger dividend payments. These larger dividends payments are then used to buy more shares and so on, generating ever increasing amounts of dividend income.

While in the early years of your dividend reinvestment ‘programme’ the difference between cashing-in your dividends and reinvesting may appear small over time the difference is likely to be huge.

Let me show you the difference . . . using the example of our hypothetical investor who has invested £15,000 in British American Tobacco (“BATS”) shares during a 15 month buying ‘spree’ (June 2008 – August 2009).

Below you can see what our investor’s shareholding in BATS is currently worth (updated until 30 April 2012).

Also shown is the total amount of all dividends received until now, taking into account the number of shares owned at each payment date (841 shares). Finally, total return is based on the appreciated value of our investor’s shareholding plus all dividends received so far.

Dividend reinvestment in action

But ‘what if’ our investor would have purchased more shares in BATS every time when the company paid out a dividend.

This is what would have happened . . .

Not only owns our investor more shares but also the amount of dividends paid has increased.

As British American Tobacco pays out dividends twice a year, the difference between the investor who has cashed in his/her dividends and the investor who has reinvested the dividends has already become apparent. Slowly his/hers total return is ‘creeping up’.

For as long as our investor holds on to his/hers shareholding in British American Tobacco and continues with the process of dividend reinvestment you are buying more future profits and dividends for the same amount of money (£15,000).

Final words on dividend reinvestment

Dividend reinvestment offers a way to turn even a little money into a lot larger amount over time. But time is of the essence! The longer you can deploy this simple strategy the larger the end result is likely to be.

However . . . while the reinvested dividends will purchase additional shares, you will not always lower your overall purchase price. Only if the reinvested dividends are invested in shares at a price below your original purchase price your dividend reinvestment programme is running on steroids.

Remember, fewer shares will be purchased when prices are higher and more shares when the price is down.

Nevertheless, as investors reinvest their dividends, the extra shares purchased will still cause returns to rocket ahead when share prices finally recover.

What next

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