With all the investment advice you hear from advisers, brokers and Wall Street regarding reinvesting dividends, they all seem to say the same thing. That is, reinvesting dividends is a good thing because there are no brokerage fees, it helps with compounding and you can purchase parts of a share. I am not saying that it is bad, but until recently I never looked at the flip side of reinvesting dividends even when the stock is overpriced.
Looking From Another Angle
If the purpose of intelligent or value investing is to not overpay or pay ridiculous prices for companies, why would that not apply to dividends? Effectively, reinvesting dividends is the same as purchasing even a smaller amount of the company. If the company that you are investing in is currently underpriced, it would be ok to continue reinvesting, but what about when the company is close to or above its intrinsic value? The purpose of calculating the company’s intrinsic value is to find those that are selling for less than they are worth. So why pay a fair value or more when you are not getting that discount and margin of safety we must adhere to?
Is it a Good Idea?
Some swear by it. Mainly Wall Street and their overpaid crew. Just because there are no fees, why overpay for anything?
I don’t like to overpay for an investment, period. An exception is if I find a great growing company with an excellent growth plan, but the majority I just pass on. The purpose of investing is to gain money/returns, not to increase the size of your holdings. It would probably be better and smarter to save up those quarterly “allowances” and save it for your next great idea, that is on sale and selling with a huge margin of safety.
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February 20th, 2010 at 9:16 am
Jae,
I’m especially appreciative of this article because I too have been mindlessly reinvesting my dividends when I first started to invest. It’s only during/after the carnage of 2008 where the thought occurred to me that perhaps leaving dividend reinvestment on autopilot mode was not the best idea.