A fundamental aspect of the capitalist system is accumulation of and investment of capital. It is capital that fuels the smallest start-up and the largest Fortune 500 Corporation. Companies secure needed working and growth capital through the use of debt and equity. The sale of stock in a company is another expression for raising equity. The stock market exists solely for letting companies and investors buy and sell stock in public companies.
The principle that drives the decision to invest capital in any business is an expectation of receiving a return on capital and a return of capital. The return on capital invested comes in two forms. The first occurs when a company pays a dividend. Just as interest is paid on debt, some companies pay a dividend on stock held by those who invest in the company.
The second form of return on capital invested in stock is the appreciation in the price of that stock. A share of stock sold through the stock market at a higher price that when purchased fulfills the principle. It provides a further return on the investment as well as a return of the investment.
The Dividend as an Investment StepchildTrading in stocks and equity is both an art and a science. The complexities of the process absorb some of the best minds and most powerful computers. Endless strategies, theories and techniques attempt to beat the market averages.
In all but a very small percentage of cases, the goal of this activity is to achieve stock price appreciation. The dividend is considered in the formulas, but it is seldom a key objective. Many large companies do not even pay dividends.
The more conservative, long-term players in the stock market do not ignore dividends. They value highly companies that consistently reward shareholders with a percentage of the profits earned. Their long-term track records prove the correctness of their attitude. Warren Buffet, one of the most successful investors of all time, learned this concept from Benjamin Graham decades ago. Graham established himself as one of the fathers of value investing.
The Magic of Compounding Applied to a DRIP StrategyA growing segment of investors understand the role of a consistent dividend as a hallmark of a solid company. They also take this insight to another level. Dividend Reinvestment Programs (DRIPS) allow the direct reinvestment of a dividend back into a company's shares. This increases the holding in a proven investment. Then, that dividend earns dividends.
DRIPS are a proven method of increasing long-term returns when you invest in the stock market.