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The Importance of Reinvesting Dividends

Over the last month, shares of Pure Industrial Real Estate Trust (TSX:AAR.UN), or PIRET for short, paid out a monthly dividend of $0.026 per share, which could either be taken as cash or reinvested into additional units. While most investors do not hold enough shares to reinvest the dividends, those who do still accept the cash more often than enrolling in the automatic reinvestment plan.

While shares of PIRET have performed exceedingly well for a real estate investment trust (REIT), returning more than 30% over the past year (in addition to the dividends), an interesting question recently came up: “Just how important are dividends in the grand scheme of things?”

The short answer is that it depends on the timeline. The long answer is, “Let’s do a few calculations.”

Using PIRET as an example, investors who chose to reinvest their distributions in additional shares one year ago had the opportunity to purchase one additional share by owning approximately 200 shares. One year ago, shares traded at approximately $5 per share, and the dividend was the same $0.026 per share.

As the dividends are paid monthly, those reinvesting the dividends would have approximately 12 additional shares at the end of the year, bringing the total to 212 shares. At a current price of approximately $6.65, the 12 additional shares are worth about $80, otherwise expressed as 5.6% of the total investment.

To simplify this situation, let’s assume an investor owns 100 shares in a stock currently trading at $25 and paying an annual dividend of $1. The investors is paid $100 in dividends and reinvests into four additional shares of the company. If one year later, the shares have risen to a price of $30, then the price return would be 20%, calculated as 5/20.

The conundrum faced by investors is trying to figure out just how much the dividends of $100 are really worth over a longer period of time. The four additional shares bought for $25 (from dividends) have increased to a value of $120, making up 3.84% of the total amount of the position. This is calculated as 4/104 shares.

Expressed otherwise, the $120 can be divided by the initial investment of $2,500 (calculated as 100 shares multiplied by $25). The current value of $120 divided by $2,500 is now 4.8%, showing that the growth in the shares received from the reinvestment of dividends is significantly more important than otherwise expected. The importance of dividends can be realized very easily. The harder part is trying to figure out how they behave over a longer period of time.

Had the $100 of dividends not been reinvested, then the value would not have increased to $120, instead leaving the $100 available for reinvestment elsewhere.

The importance of dividends goes hand in hand with the importance of reinvesting those dividends and experiencing the growth in those new monies. While most investors are very happy to receive the dividends, we must realize the importance of taking things one step further and give additional thought of where to reinvest those cash flows. For example, over the past year, investors may have been the ones plundering the shares of PIRET!

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Fool contributor Ryan Goldsman has no position in any stocks mentioned.

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