Buying dividend stocks can be a great way to generate passive income. Dividend income takes time to compound, though.
In my view, three of the best dividend stocks in the FTSE 100 are BAE Systems, BP, and Legal & General. Investing £1,000 into each of these today would generate around £171 in dividends this year.
But how much passive income would I be making today if I’d bought these shares five years ago, reinvested the dividends, and let compounding do its thing?
BAE Systems
Let’s start with BAE Systems. Five years ago, the company’s share price was £8.10, meaning I could have bought 123 shares with an initial £1,000 investment.
Since then, I could have increased my investment in the company by reinvesting my dividends to buy more shares. Doing this would have increased my holding to 151 shares by now.
Increasing my share count would also have increased my dividend income. Factoring this in means that I’d have received £157 in dividends over the last five years.
This year, the company is set to distribute just over 25p in dividends per share. With 151 shares, I might therefore expect to receive just under £39.
That’s a 3.9% annual return on my initial £1,000 investment, compared to the current dividend yield of 3.1%. Starting five years ago would have given me a significant boost over investors buying today.
BP
BP is another stock that has paid highly variable dividends historically. The company cut its dividend per share in half in 2019, which is an indication of the risks involved in dividend investing.
Five years ago, £1,000 would have bought me 209 BP shares. Back then, that would have generated around 31p in dividends per share.
By reinvesting my dividends over time, I’d have managed to increase my holding to 220 shares. With the current dividend levels, this would bring in £38 in passive income.
The BP share price is lower than it was five years ago. That means that an investor buying shares today would get a better yield than me if I’d owned shares for the last five years.
BP shares today have a dividend yield of 4.4%. If I’d bought the stock five years ago, my yield on cost now would be 3.8%.
Legal & General
At today’s prices, Legal & General shares have a dividend yield of 9.7%. How does that compare to what I’d get if I’d invested five years ago?
Investing £1,000 in Legal & General stock five years ago would have bought me 386 shares. The share price is currently close to where it was in 2017.
Reinvesting dividends would have increased my stake to 535 shares. With the company paying out almost 19p per share in dividends, that should bring in over £101 for me this year.
That’s a 10% annual return on my original investment. I think that’s attractive both in absolute terms and compared to the 9.7% available to investors buying the stock today.
Passive income
Investing £1,000 in each of BAE Systems, BP, and Legal & General five years ago would mean that I’d be receiving around £178 in dividends annually. By continuing to reinvest, I’d be able to increase my passive income even further.
