Shares will be running a series of Christmas features explaining the top 10 golden rules of investment.
Rule number 2: Focus on dividend reinvestment
Dividend reinvestment is the key to superior long-term returns, as the chart below illustrates. Based on the UK equity market’s historic 30-year compound average capital gain of 7% and 3.6% dividend yield our example shows how £1,000 could be worth £20,767 in nominal terms three decades on, if dividends are harvested and reinvested as the UK market matches its historic return profile (see black line).
The gold line illustrates how £1,000 would become only £7,655 nominal over 30 years if you banked the capital gain alone and took no dividend yield at all. The £20,767 figure is based on reinvesting net dividends, the actual amount paid by the firm after HM Revenue & Customs retains its 10% slice to via the dividend tax credit. Higher-rate tax payers need pay an additional 25% tax on dividends received, unless the shares are held within an Isa or Sipp.
Prime pick: Reckitt Benckiser (RB.) £48.46
Investors seeking to harness the benefits of dividend compounding might reinvest the plump payouts offered by Reckitt Benckiser (RB.). The consumer goods colossus makes and markets a comprehensive range of high-quality health, hygiene and home brands ranging from Durex and Dettol to Vanish, Strepsils and Nurofen. The £34.9 billion cap faces short-term challenges such as foreign exchange headwinds and slowing emerging markets, yet it has many competitive strengths, notably geographic diversity to brand strength and pricing power.
Last month’s (16 Apr) first-quarter results showed like-for-like sales growth of 4% to almost £2.2 billion, stripping out the pharmaceuticals division which is under review. The numbers reassured Reckitt Benckiser can hit full-year targets. Consensus expects the cash-generative and robustly financed Reckitt to pay a 137p dividend this year and a 144.2p next, from earnings per share of (EPS) 262.4p and 275.9p respectively, for a prospective 2015 dividend yield of 2.9%. The FTSE 100 stalwart’s non-core pharma arm could be sold or even spun-off into a separately-listed business.