Before you dive into the details, it's important to understand how and why investment accounts consisting of dividend paying companies grow in value.
Which Companies Pay Dividends
Dividend paying companies are often mature businesses in a somewhat predictable industry such as food, energy, or consumer goods. Chevron for example pays a dividend, whereas Google does not. This doesn't mean Chevron is a better company than Google, it's just a different type of company. Chevron rewards its shareholders with a combination of dividends and hopefuly share price appreciation whereas Goolge uses share price appreciation only. Chevron is an income and growth company, whereas Google is a growth company only. If you're curious to know which companies pay a nice dividend, here's a list.
Investment Growth from Dividend Income
When you invest in a company which pays dividends, your investment account will see an increase in value every time a dividend is paid - even if the stock price remains flat year after year. And more important, when you reinvest these dividends back into the company (for example buy more shares of the same company, or buy shares of another company with a similar dividend), the amount of your dividends will grow, because next year you'll have more shares generating dividends and feeding your investment account. Dividend reinvesting is like a snowball rolling down a hill ... it gets larger with time. This is similar to the idea of earning compound interest, and how a bank savings account would work.
Investment Growth from Appreciation
The second component of investment growth is due to the management prowess of a company and general market perception. Some companies have exceptional management and do better than their competitors, thus the market bids up the stock. Unlike a savings account which can only grow via interest earned, an investment account can grow in value because the companies in your portfolio are doing well. In short, if a company is proven or perceived to be growing, its market valuation (the share price) goes higher and shareholders benefit. Of course, just the opposite is true if the company is not perceived to be growing, is perceived to have reckless management, or is proven to be shrinking.
Even Higher Dividends
This investment calculator bases future years' dividends on the total amount of your investment at year end including paper gains from stock price appreciation and any contributions you made.
You estimated that your dividend yield will be 0.00%. Here's where the growth factor comes into additonal play. In order for the dividend yield to maintain itself in future years, one of two things has to occur:
1.) the company's share price never grows and remains flat and thus so does your dividend yield of 0.00%.
2.) the company increases the dividend to maintain the yield as a percentage of the growing share price. Companies often set a dividend target rate, and as the company's share price grows, so too does the dividend in order to maintain that dividend yield of 0.00%. In other words, your dividend payment keeps pace with the stock price! The implication of a target "payout" rate is that your dividend has a natural growth rate - as the company grows so does your dividend. There is no guarantee a company will raise its dividend to remain consistent with a growing share price, but for practical reasons (meaning to keep shareholders happy), companies often do this as a way of rewarding shareholders or in corporate speak, to "enhance shareholder value". In short, if the company is growing and earning more, it pays you more. This is one reason why I prefer dividend income as opposed to interest income. In inflationary times, dividend payments tend to keep pace with inflation, whereas savings account interest may not necessarly keep pace.
Dividend Forecasts Are Very Good Things
In my view, there is no better investment news, other than perhaps a company buyout at a premium, than a positive dividend forecast. Chances are good, but not guaranteed, that the share price will be moving higher.
It would be highly unlikely for a company to announce it expects a higher share price next year. Indeed, the company would purposely steer clear of such language as it might set itself up as a target for shareholder litigation in the event the share price did not increase. However, companies sometimes telegraph their expectations for the amount of dividends to be paid. Whereas a company will not, for the reason mentioned above, forecast an actual dividend dollar amount, it may forecast a generalized increase relative to the existing dividend, such as by saying "we expect to grow our dividend (or in the case of a partnership, distribution) by 5%".
What is management saying? They are saying in relatively safe suggestion that they expect to earn more cash than they are earning today. Better yet, they intend to send that additonal cash to you, in the form of a higher dividend. How can they make such an assumption? Because the managers have successfully grown the company and set it on a more profitable path. Maybe they've opened a new factory, or developed a new base of customers. Whatever the case, more money is flowing in than before, and there is more money to distribute to you, the shareholder.
So why is a forecast of an increasing dividend a positive event? Because it implies two events: the cash paid to you will be higher. And, the share price will, in all likelihood, be higher as well. Why would the share price be higher? Because new and existing investors will bid up the price per share in order to buy the security and lock in the dividend yield. It's the combined effect of a rising dividend, plus a rising share price, which equates to what is known as a "total return", and in the end, that's what matters most: the total return on your investment.
But Not All Dividend Forecasts Are Very Good Things
When a company announces its expectations of an increasing dividend, it's time for a reality check. First determine why the dividend is increasing. If it is due to the company's management growing the company, it's generally a good thing. If it is due to expectation of more revenue due to an external market force - for example the price of oil being transported in a shipping company's tanker, or the latest market fad - be careful! External market forces are not always sustainable. When a company announces a dividend increase, check their web site for a history of dividends. Those that have successfully increased their dividend, and maintained the increase, are likely to continue to do the same. Those companies that have increased, and then chopped their dividends are likely to continue the behavior. Their dividend, with the ups and downs, is a slave to the market, which can cut both ways. And as the dividend gets chopped, so too may the stock price as investors flee in search of something better. This is doubly painful for those still holding the security.
Too Good To Be True?
Be wary of a dividend yield that looks too good to be true - it probably is just that. Companies sometimes dangle a large dividend in hopes of attracting investors. And it often works. But if the company subsequently slashes the dividend, more often than not it means the company is in trouble and needs to conserve its cash. If a company is perceived to be in trouble, the share price will suffer. How do you determine if a dividend is sustainable? Compare it to what other companies in the same industry are paying. If the dividend looks abnormally high, you may be looking at a company offering abnormal risk as well. Within the definition of total return, a higher than normal dividend will not do you any good if the stock price gets cut in half when the company runs short on cash.
What About Taxes
You're figuring a tax rate on your dividends of 0.00%.
Reminder: Because you entered a tax rate of zero, this implies you may be investing within a retirement account and your dividends are not taxable. If you want to view the impact of dividend reinvestment in a regular taxable account, it's important to use a tax rate, because nearly all dividends are taxed (unless they are in a retirement account).
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