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Telstra and the magic of getting rich from dividends

After the global financial crisis, the broking community was adamant that we were entering a “new normal” investing environment. This would be typified by prolonged periods of both lower growth and returns, as well as shorter and sharper economic and market cycles. Apparently, the old strategy of buy and hold would no longer apply. This Fool begs to differ in the case of Telstra (ASX: TLS).

The capital gain on Telstra from November 2010 to the current date is 94%. Once the dividend and franking credits are applied, the gain is increased another 50% to 144%.

Thus, the invisible hand of the early stages of the Rule of 72 is at work. That is, should an investor hold a stock for 10 years, a dividend of 7.2% per annum is required to double the investment. This falls to 7.2 years if the average annual return is 10%. No capital gain is required to achieve this gain.

The Rule of 72 has been supercharged in the Telstra example by a dividend yield of 14% when the shares were below $3.00. The capital gain resulted from both the potential for rising dividends over time and the increased appeal of dividends over a falling cash rate.

Looking forward

Telstra does not have a dividend reinvestment plan, which typically would allow the purchase of additional shares at a discount. As it is not regarded as a high growth stock, one effective strategy is to reinvest those dividends into higher growth alternatives. Three such possibilities in the same telecommunications space are TPG Telecom (ASX: TPM), iiNet (ASX: IIN) and M2 Telecommunications (ASX: MTU).

In the event of a market downturn, it should be noted that dividend paying stocks often retreat less and sometimes rise. This is because they are typically mature profitable companies, with stable outlooks and continue to generate cash.

Foolish takeaway

Telstra is clearly a lesson in the magic of investing in blue chip companies with sustainable and potentially rising dividends. Human nature may dictate that many shareholders would sell their holdings with a sigh of relief when the price approaches their original purchase price.

This would be understandable, with many investing in the second tranche of shares, sold by the government at $7.40 or later near the all time high of $9.20. Let’s hope a realistic assessment of the dividend and growth prospects at the time are their main considerations.

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Motley Fool contributor Mark Woodruff owns shares in Telstra.

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