In my previous post, I eluded to the fact that an investor can actually benefit from a fall in the price of a stock which they currently own. While this may seem counterintuitive, a simple demonstration will help to explain how this is possible.

The first requirement for this to happen is that you need to be in the investment for the long term. This will help for two reasons. The first reason this will help is because by being in the investment for the long term, you should be more concerned about the dividends you are receiving and the performance of the company than the price of the stock. Secondly, we should remember than the stock price of any solid company will generally rise over time and so any fall in the price of the stock is only temporary and eventually, it will be higher than it was before the fall.

The second requirement to benefit from a fall in the price of a stock that you currently own is that the company must pay dividends. If the company does not pay dividends, your only source of gain is in the stock price and a drop in the price means a loss for you. If you own stock in a company as a long term investment and that company does not pay dividends, you may want to rethink your strategy to begin with.

Most of the companies that pay dividends are proud of this fact and most of them will have a link on their investor relations portion of their website that will show their dividend history. Companies like to be able to say that they have consistently paid a divided for x number of years and have raised the dividend y number of times during that period.

Now, how to benefit from a fall in the price of the stock. Companies pay dividends based on the number of shares you own, regardless of the price of that share. For this example I am going to use a fictitious company and make up numbers that will be easy to calculate. If this company currently pays $1.00 per share on a quarterly basis and you purchase 50 shares of this company, you will be making $50.00 per quarter or $200.00 per year on this investment.

To truly invest for the long term and take advantage of the power of compound interest, you set this investment up for dividend reinvestment. If you purchased this stock at $62.50 per share, and the price stays the same throughout the first quarter or is back to $62.50 at the end of the first quarter, your reinvested dividend will buy you another .8 shares. The next time dividends pay, you will get $50.80.

Say the price of the stock jumps to $72.50 by the end of that second quarter. You still made money because your 50.8 shares each increased in value by $10.00, but your divided this time only buys you about .7 shares even though your divided is larger. After two periods, we now have 51.5 shares of a company paying $1.00 per quarter in dividends.

For the third quarter, let’s say that the price drops to $51.50 per share by the end of the quarter. Our $51.50 in dividends will purchase an entire additional share. This means that next time we will get a dollar more than we did this time.

While the numbers in this example were completely made up, the point that I show is obvious. If you find a company with a good record of dividend payments, you will be able to benefit if the share price falls in the short term. Your dividends will buy you more shares for the same amount of money and the more shares you have the more dividends you will get next time. As a bonus, when the price of the stock goes back up (remember that over a long period, the price will generally increase) you will make more because you will own more shares.