Reinvestment

The essence of compounding is that investments grow exponentially and not in linear fashion because it assumes that cash flows from an investment are reinvested such that cash distributions are added to a principal sum invested so also attract interest and other cash distributions. In an equity context, shareholders can opt to use their dividend payments to purchase additional stock in the company rather than take it as cash income. Because this form of reinvestment gives a shareholder an increasing number of shares in a company over time, it gets us back to the notion of compounding.