The glorious dividend: Reinvesting dividends for superior returns

For many Nigerian investors, dividends are a welcome reward for their trust in a company.

They represent a portion of a company’s profit shared directly with shareholders. But what if we told you there is a strategy to turn this reward into an even greater return?

Investing in stocks is a journey, and dividends provide a steady stream of income that enhances your investment returns along the way.

Are you eager to know what happens when you decide to reinvest your dividends?

A recent Coronation Research study reveals just how much reinvesting dividends can amplify your returns over time.

The study reveals that by reinvesting from 2016 to 2023, the total Nigerian equity market return accrued to an impressive 304.6%, compared to just 212.7% when not reinvested.

This highlights the power of compounding – essentially, your earnings grow on top of your earnings, turbocharging your investments to yield more than you had expected.

This reinvestment strategy works best with stocks that consistently make good profits, known as high Return on Equity or RoE.

By reinvesting your dividends in these strong companies (whose stocks offer high RoE), your money can grow faster than inflation and beat returns you might get from safer (less risky) options like fixed-income securities such as bonds.

This makes reinvesting a great strategy for people who want to build their wealth over the long term, like for retirement.

By focusing on companies with high RoE, investors are selecting businesses that are efficient in generating profit from their equity capital (the money raised by selling shares of ownership to investors known as shareholders). These companies typically have strong management teams, competitive advantages, and robust financial health, which allows them to consistently deliver superior returns on shareholders’ investments.

Nevertheless, it is still important to consider the impact of inflation on your returns when you reinvest. Even with a high RoE, if inflation is also high, the actual purchasing power of those returns may be reduced. This is crucial for long-term investors to note because inflation can erode the value of their investments over time.

While offering stability, fixed-income securities often provide returns that may not even keep pace with inflation, making them a less attractive option in high inflationary environments.

Understanding the power of dividends

Dividends are more than just periodic payouts; they are a critical component of the total return on equity investments. When shareholders reinvest their dividends, they purchase additional shares, compounding their investment. This strategy leverages the growth potential of high-performing companies, enhancing overall returns.

For instance, from 2016 to 2023, the NGX All-Share Index grew at a 15.3% compound annual growth rate (CAGR). However, when dividends were reinvested, the total return soared to a whopping 19.1% annually. (The NGX All-Share index is a tracker for the performance of all companies listed on the exchange, regardless of their size or industry).

The power of high RoE stocks

High RoE equities consistently deliver superior returns and are capable of sustaining regular dividend payouts. The Coronation Research model portfolio, which is composed of NGX-listed companies with RoEs exceeding 20.5% annually, exemplifies this. These companies offer robust profitability but also reward shareholders with significant dividends, which, when reinvested, boost the total equity return beyond standard market indices.

Overcoming volatility

Despite the historical volatility of equity markets, the strategic reinvestment of dividends provides a cushion against market fluctuations. During downturns, reinvesting dividends at lower prices can yield higher returns when the market recovers. This was evident in 2020 when the NGX All-Share Index returned 50%, while the total equity return, bolstered by reinvested dividends, reached 62.4%.

Long-term investment horizon

For long-term investors, such as pension funds and mutual funds, embracing a dividend reinvestment strategy is crucial. Despite the volatility, the long-term benefits of superior total returns far outweigh the short-term risks. Nigerian pension funds, which currently have a low allocation to equities, stand to gain by increasing their exposure to high RoE and dividend-paying stocks.

Beat the market

Reinvesting dividends is a powerful strategy for achieving market-beating returns. By focusing on high RoE stocks and leveraging the compounding effect of reinvested dividends, investors can enhance their total equity returns, often beat inflation, and outperform fixed-income investments.

As evidenced by a Coronation Research study, this approach is viable and essential for maximising investment success in the Nigerian equity market.

For investors seeking to maximise their returns through dividend reinvestment, Coronation Registrars offers an efficient service to manage your investments.

Partner with Coronation Registrars to unlock the full potential of your equity investments and achieve long-term financial success.

Enews Nigeria