Wise investors let compounding work its magic

[CityFarmer]

I find this compounding article very very interesting.

How do I put this into practice myself?
Do I invest in a company that after I have done my homework in valuing it properly, simply reinvest my dividends in the company over and over again? Is this what it means?

By starting with a small capital and receiving small dividends, keep reinvesting the small dividends back, and by the 7th year onwards (mentioned from the article), this small dividends would have played a significant role into increasing the portfolio size and thus small dividends will become bigger dividends? And continue in the same pattern?

Is this compounding method still applicable now and will continue to work for the next 100years?

Yes, compounding works like newton laws, will continue to work after 100 years or more. The catch is to ensure consistency on the yearly dividend for 100 years. It is already tough to ensure 10 years...

[TheMillennium]

Hi Cityfarmer,

I just did the excel spreadsheet, starting at 10k and assuming 5% dividends for the next 20years, and purely just reinvesting the dividends, at the end, I would get 26.5k.

But it is most likely that a person would definitely add in more investing capital besides the dividend yield. Once again assuming adding around 5k every 5 years, at the end of 20years, I would get about 45k.

For me, as I do not really have any commitments, I only see the rosy side haha..
Can you please elaborate a bit about why you say it's tough? Besides the "getting married, HDB & car loans, sickness, inflation, sudden large expenses" stuff.
Will SG companies be able to sustain for 20years? Management would have undergone many changes, for better or for worse, and will my conservative calculations still hold?

Just to better phase the question, what can cause my calculated prediction to fail?

Thanks!

[Musicwhiz]

I just did the excel spreadsheet, starting at 10k and assuming 5% dividends for the next 20years, and purely just reinvesting the dividends, at the end, I would get 26.5k.

Just to better phase the question, what can cause my calculated prediction to fail?

Why assume 5% throughout? What happens if dividend dips or is cut for one of the years?

Also, capital addition is a wild card - you will not know how much you can pump in; and pumping in when capital is small results in large % changes.

[TheMillennium]

Why assume 5% throughout? What happens if dividend dips or is cut for one of the years?

Also, capital addition is a wild card - you will not know how much you can pump in; and pumping in when capital is small results in large % changes.

I totally forgotten about this! % changes when initial amount is small will result in the % increase/decrease to be big!

Thanks for pointing that out!

[Temperament]

I find this compounding article very very interesting.

How do I put this into practice myself?
Do I invest in a company that after I have done my homework in valuing it properly, simply reinvest my dividends in the company over and over again? Is this what it means?

By starting with a small capital and receiving small dividends, keep reinvesting the small dividends back, and by the 7th year onwards (mentioned from the article), this small dividends would have played a significant role into increasing the portfolio size and thus small dividends will become bigger dividends? And continue in the same pattern?

Is this compounding method still applicable now and will continue to work for the next 100years?

Yes, compounding works like newton laws, will continue to work after 100 years or more. The catch is to ensure consistency on the yearly dividend for 100 years. It is already tough to ensure 10 years...

Yes it is very tough for me even a few years. And i think not many companies survive for 100 years. That's why some people believe in index investing only.

[specuvestor]

Compounding is magical but the execution in compounding is different.

A stock that compounds 10% in capital a year and a stock that pays out 10% dividend are different. Academically both have 10% annual return

But the ROIC for an investor for the former is the same 10% but not for the latter. By then 5th year when the investor gets back 1/2 of the money, the ROIC doubles. At the end of 10 years it is effectively infinite (whatever that means). Practically it means u have the same asset that generates 10% cashflow with zero counterparty risk, while the former you need to sell the asset in order to realise the cashflow, with double the counterparty risk.

And hence wealthy people focus on this little understood subject that's probably taught in 5 minutes in Finance 101: payback period. In a certain sense, PE is exactly what that is: the no of years to get back your investment if the return is constant.

That's how Buffett does it... and he did it at least 6 rounds (ie 6X 10 years) That's 64 times his original capital plus other cash thrown out and compounded again. IMHO the hardest thing to emulate Buffett is patience

[CityFarmer]

I don't know for any Singapore stock has consistent 20 years of >5% dividend. SPH has 10 years dividend history of above 5%. Since i have only 10 years data, so not sure it is so beyond 10 years.

You prediction is not flaw, but it highly depend on "the" company performance in the next 20 years, which might include 2 bull-bear cycles (assuming 7 years cycle)

IIRC, average return from stock investment is around 10% (both by capital appreciation and dividend). IF you manage to beat the average and take full advantage of compounding, the end result after 20 years is more than 74K

[paullow]

thats a fair n reasonable return. i guess for most its the more conventional way to create wealth n sustain it. for starters that would seem a safer bet.

once u get pass that stage n u r comfortable with investment, perhaps it might be time to think bigger. get a glimpse of how the most fasinating tycoons of sea create their immense wealth thru reading up and researching on their moves. pple like peter, ohl, koh bh, queklc etc. go where ur comfort level n risk appetite would take u. think big. but this will take time...

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and not forgetting some help from lady luck.

[a74henry]

Compounding requires patience for your investments to grow and the belief that you have invested in the right asset.