Buying and holding dividend shares can be a very effective way of earning a second income. And reinvesting over a long period can boost returns even further.
I’ve been thinking about my stake in Diageo (LSE:DGE) recently. In particular, I’ve been trying to figure out what sort of return I might get 30 years from now.
The current situation
At the moment, I own 1,216 Diageo shares. That might sound like a big investment, but it used to be bigger – the stock’s down around 35% since I started buying.
Right now, that generates around £912 a year in dividends, which is… fine. But the falling share price means the yield’s gone up significantly since I’ve owned the stock.
As things stand, the dividend yield’s 4.25%. So I can increase the number of shares I own by that much each year just by reinvesting the dividends, if things stay as they are.
Over 30 years, the significance of this shouldn’t be underestimated. It means 1,216 shares could become 4,554 without me having to invest any new cash along the way.
Based on the current dividend, that’s £3,415 a year. But if Diageo keeps increasing its dividend by an average of 3.5% a year – as it has in the past – the total becomes £9,289.
That’s my expectation for Diageo. But the question is whether that’s what I want to do with my dividends. Or are there better opportunities elsewhere in the stock market?
Investment outlook
Diageo’s competitive position looks extremely strong to me, but demand across the industry has faltered recently. And the concern is that this might be a sign of things to come.
LVMH however, reported unexpected sales growth earlier this month. But its alcohol division was driven by higher wine volumes, with spirits continuing to falter. On the face of it, that’s not hugely encouraging for Diageo and its spirits-focused portfolio. But I think there is reason for shareholders like me to view this positively.
As I see it, the main risk with the stock isn’t consumers switching from spirits to wine. The reverse has been happening for some time and I expect this to continue. Instead, I think the biggest threat is a secular decline in alcohol volumes. And one of the major catalysts for this is GLP-1 drugs, which have been growing in popularity recently.
On that front though, LVMH’s results are encouraging. They suggest that a lot of the recent weakness in the alcohol industry has been cyclical rather than permanent.
Keep buying?
For the time being, my plan is to keep reinvesting my Diageo dividends to buy more shares and see where that takes me. With the yield above 4%, I think it looks attractive.
I am however, keeping my eyes open. Specifically, I’m watching to see how far the rise of GLP-1s turns short-term weakness in demand develops into a long-term issue.
Equally, my assessment of the value equation might change if the share price goes up and the dividend yield comes down. But at the moment, I’m happy to keep building steadily.
