Another day, another argument on reddit about investing and logical fallacies.
I was pointing out to someone that the decision to hold a stock is the same as the decision to buy a stock because of opportunity cost. Some people didn’t believe me, so I ended up writing this rant:
es, but here are some examples that might make it clearer.
Let’s look at BP stock.
In March of 2010, the stock was trading at 57. Then the deepwater spill happened. In April of 2010, the stock was at 29. It was a huge drop. Holding BP in April 2010 is mathematically equivalent to buying BP in April 2010. Whatever you paid for the stock in the past is irrelevant (except for tax purposes). To think otherwise is to fall victim to the sunk cost fallacy.
So if you were a holder/buyer in those dark days of horrendous press for BP, then you assumed either explicitly or implicitly that the then-current stock price did not reflect the long term value of holding the stock when factoring in dividends and capital gains.
If, on the other hand, you believed that these events were going to permanently reduce the prospects for BP’s stock, then it would be wiser to sell and move the money into something with a brighter future.
In this particular case we can see several years later that the person who held would have made about $13 in dividends (not reinvested) and about $5 in capital gains for a total return of 62%. If he had dumped the stock and bought the S&P 500, he would have doubled his money….
And the point about dividends not being reinvested got me thinking. I’ve been reading my friend Matthew Paulson’s book on dividend growth investing.
So what would happen if you were holding BP through the Deepwater Horizon spill, all the associated bad press, and kept reinvesting dividends?
Let’s take a look at the chart:
We can see that after the spill the stock crashed by about 50% and dividends were suspended for a few quarters.
This is a disaster for any dividend buyer.
So before we run the numbers on BP, let’s look at what has happened with the overall market since that time.
So if your hypothetical BP holder had dumped everything and bought an S&P 500 index fund, a hypothetical $10,000 would have grown to $21,930.
Now let’s run the numbers on BP and see what would have happened if instead of selling, our intrepid investor persevered and held the stock while reinvesting all dividends.
If our investor friend had $10,000 worth of BP at the bottom of $28.88/share then he would own 347 shares.
So here’s what happened…
The $10,000 grew to $15,858. As it turns out with the price of oil crashing over the last few years in general, it would have been better to dump the stock and buy the index in terms of total return. But another way to look at it is in effective yield. The current payment on the original $10,000 investment represents a 10.87% yield.
And that’s not too shabby.