Wednesday, April 22, 2015

Experiments with the Dividend Reinvestment Spreadsheet #2

Hello, this is Div4son.



Last time, we talked about the importance of understanding the time component of dividend reinvestment, and being patient during the process.

You can read the article here - http://div4son.blogspot.com/2015/03/patience-and-time.html

The assumptions in my first spreadsheet were simple in nature -- the market will constantly go up (or go down if you put negative growth).

Last week, I tried to see if I can implement a simple model of the market - allowing the price of the shares to go up or down randomly. I added a couple of trend lines (one short term, one long term), with year over year changes completely random.


If you are interested, you can download the updated spreadsheet here:

https://docs.google.com/spreadsheets/d/1Ytd7XD04WjtjG0mqY7q7Mr62P89OSzDCVaKe-ihzj64/edit?usp=sharing

With this updated spreadsheet, I can run a series of experiments to see the impact of dividend reinvestment over time with a basic modeling of Mr. Market. Of course, the market is much more complicated in real life. However, after a series of experiments/simulations (100+ runs), I notice 3 outcomes -  the market could either go up, down or stay the same.

For the experiments, I used the following assumptions with time=20 years:


Price100
Share #100
short price variance35.00%
short price cycle6.0
long price variance3%
long price cycle40
div3
div growth3.00%

The price, share #, div & div growth are self-explanatory. The short price cycle & variance are for the short term trend. The long price cycle & variance are for the long term trend. 

1) Market goes up






In this scenario, we are all happy campers.Valuation at 20 years is 3.5x the original investment. Dividends are 3x the first year's dividends. Overall, not many down years. Only during year 6 where there is a minor bump in the road (but still positive).

2) Market goes down





In this case, after 20 years, the price of the shares are down 40% from original price. In case of valuation, there are a few years when an investor will lose some sleep - e.g. Years 4-6, 12 and 18. However, at 20 years, the gains are still positive (x1.6). The interesting thing is that the dividends per year will gain significantly; you are looking at 4x the original year-1 dividends. 

3) Market stays the same





In this case, this market is fairly flat. However, your valuation is 2.2x the original investment. The dividends per year will also gain  4x the original year-1 dividends. Not many bumps in this scenario - and not that exciting either.

Summary

If you could wait it out (20+ years), in almost all the above cases, your valuation is positive after 20 years - even when the market goes down . 

In all cases, you see significant gains in your monthly dividends.

The only case where it failed was if a company fails i.e. price = 0.

The first step in all of this is to find quality companies that can survive through recessions and give you continuous dividend growth. If you buy the companies at good valuation, then this will reduce your heart burn during the years where the valuation can be -30 to -50% for extended periods. If you have the patience, you will be rewarded with high dividend income and high valuation under all the different market conditions.

Again, my spreadsheet is a simple model. In real life, things are much more complicated. The good thing with this simple model is that you can see what happens during the down years where your valuation can go down significantly for long periods of time (3-5 years). It is important to know how you will react and mentally prepare yourself.

Please feel free to play with the spreadsheet. You can play with different dividends, yields, growth etc. 

That's it for now. The next update to the spreadsheet is to see what will happen if you add funds regularly. I think this would be the best investment strategy, but we will see...

Div4Son


2 comments:

  1. Nice plots. I agree, focusing on dividend and underlying business fundamentals is the key here. The price of the stock is noise in the grand scheme of things.

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    1. YD, thanks for your comments. Btw, I really like your strategy on DGI stock selection.
      D4S

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