Now Is the Right Time for a DRIP

During this holiday season, I was wondering if there is any silver lining on the market conditions, and surprisingly there is. There are many books that advocate long term buy and hold strategies and advise to reinvest your dividends. There are also many websites and books that advocate investing in dividend aristocrats or dividend achievers - which are companies that have successfully raised dividends for many consecutive years.

If you have an investment program where you buy great companies with a wide economic moat that are internationally diversified, have increased dividends successfully over many years, and have a long term time horizon, this may actually be a very good time for you.

Let me explain, in a dividend reinvestment program you reinvest the dividend declared by the company back into the stocks.

Let us call the amount of shares you can buy back on the dividends as a percentage of original number of shares as “share yield.” There are two numbers that are important here - the amount of dividend declared by the company and the price you are paying to buy the stock on the dividend declared. If we are careful in our initial purchase of the stock, the original company would have the following qualities:

• Wide economic moat
• Well diversified geographically and business-wise
• History of maintaining or increasing dividends for at least 10 years or 40 quarters
• Low payout ratio
• Financially sound

These are the companies we would know will not go out of business because of a recession. As their payout ratio is low (less than 40%) they still can maintain or increase dividends even if their dividends fall. Eventually we believe the stock price will recover in a few years. Now assume the company increases as usual but the share price has fallen more than 30% from where you bought it. Now, the longer the company’s price stays lower the more you benefit, because you are getting a higher “share yield.” Here are the numbers:

click to enlarge

Recently we saw companies like Illinois Tool Works (ITW) and United Technologies (UTX) that have announced dividend increases, though their stocks are well below their peaks.

Even if the company can maintain their dividend in spite of fall in prices of 40% or more - i.e. DOW, GE, the “share yield” of these stocks goes up significantly because of the drop in their prices.

As DRIP really benefits in the long run of 20 years or more, if you project these numbers for more than twenty years we would all see a great CAGR. Continuing the example, if the company manages to increase dividends at a 15% clip for the next twenty years and the price recovers at 15% per year, we would see a CAGR of 19.9%. But we all know that there is no guarantee that this will happen and that is why we get paid an equity risk premium for this. But if you look at dividend aristocrats and dividend achievers you can see a lot of companies have done this in the past.

In other words, though the current market conditions are psychologically difficult to digest, this presents a great opportunity for investors who do their homework before buying their stock and are willing to wait with patience for long number of years. In the meanwhile we all can look at our “share yield” if we need something to feel good about.

Comments

[Paul Price:]

DRIPS made sense before commissions as low as $1 per trade were available.

Now with firms like Interactive Brokers and TradeStation offering one dollar transactions, you're better off just letting your dividends accumulate until you see a great price. Then just buy all the new shares when you know they're at a price you like.

With DRIP plans your purchase date is randomly set by the dividend payment date so the share price might, or might not, be one you think is favorable.

2008 Dec 26 07:34 AM

[funfun:]

Dow Chemical is a good long-term candidate for patient DRIP fans. Dow is well managed, growing, and now twice as large as its much shrunken and weakened chemical rival, the DuPont Company. ...funfun..

2008 Dec 26 09:11 AM

[Leser:]

Fashion had dividend stocks go out of style for sundry reasons. Now they're back and most logical to buy.
DRIPs went out of fashion also for various reasons. Now they're back again. Our author here, Ganesh Kumar, has several good points, as far as I can tell, and they are well explained. DRIPs provide good things such as dollar cost averaging as well as consistency and self-discipline in investing if one sets up an automatic withdrawl from one's checking or savings account. (Some DRIPs are as low as $10.00 minimum a month--and in great stocks.) There are no fees from many company that provide DRIPs and, in my opinion, forget about getting a DRIP from the ones that charge a fee. The fee probably should be of concern for the small and frequent investor, that's something commentor number one above is not taking into consideration. DRIPs have a place in our stock portfolios, probably if we are of that apparently dying breed called buy and hold. Or is buy and hold the next idea to return from the boneyard of investment theories? I would guess it should return and perhaps investing will be more investing in companies and less gambling with investment money to make the fast buck.
There is a logical good investment tool for each investor.
To understand this investment tool I suggest those interested to go to their bookstore and purchase one of many books about DRIPs and also investing in dividend bearing stocks.
All things old become new again it seems.

2008 Dec 26 09:29 AM

[Weissass:]

DRIP's take some of the emotion out of investing and lead to that mythical goal of compound interest. The Schwab platform allows "one-click" access to set up DRIP's at any time. It's very convenient and easy to change. I have noticed that the share price IS marginally higher on the days that the DRIP shares are bought...so the market-timers DO have a slight advantage.

2008 Dec 26 09:25 PM

[Ganesh Kumar:]

The reason DRIP is better is that the investor need not have to monitor the stock prices once the initial investment is made. The dividends are automatically reinvested periodically. My analysis has shown that if you have made the initial purchase at the right price, paying a little higher price later when you reinvest dividends should not affect the average cost that much. The trouble in taking out the discipline by accumulating cash dividends and waiting to buy at the right price is just that, determining the right price. If there is not overall strategy governing such repurchases you may end up with just cash not accumulating the shares.

Anyway the point of the article was to look at the brighter side of today's low prices and it is that DRIP investors are able to accumulate more shares than ever and that will benefit the DRIP investors in the long run.

2008 Dec 27 06:55 AM

[Trent Tucker:]

Gents, There is a great release in liquor and poetic levity.

You rogues, you rascals, you Wall Street Dancers

2005 was alive with jive
and 2006 was all high kicks
2007 was feeling just great
turned out it was bait
for what came in 08
So we voted for the line
that leads to 09
So what say in 010
don’t refinance again
Because in 2011
It has to be heaven
As much as I’ve delved
Nothing else rhymes with 2012

To sum up 2008, let a banker write a bad poem and no one cares. Let a poet write a bad check, big difference. Or maybe Richard Armour described it better, “That money talks I’ll not deny. I heard it once it said goodbye.” Eighteen months at most, probably less, and gents, Wall Street will be financing the purchase of what they just bankrupted and the Dow will be climbing to 14,000. The free market relies on victors not victims. Government relies on victims and distorted policies create opportunities for speculation. Freddie Mac and Ginnie Mae were distortions which melted down because it attracted speculators who did a 1035 rather than pay capital gains tax till there was no 1035 escape left. Meltdown, fiscal fission. Eliminate capital gains tax and profit would have been taken ages ago rather than a 1035 escape to nowhere. Wall Street got involved for the reasons I cover in Wall Street Dancers. The free market works when it is fairly regulated, not rigged as it just was. Ever heard of Glass Steagall? It was Repealed 1999 and written in 1933. It was a firewall that worked for 70 years in preventing what just happened. Wonder why it was repealed? And no one knows the difference between capitalism and a centrally controlled and distorted economy better than the Poles. Abandoned to Stalin at the beginning of the cold war they cynically summed it up the best, “Under capitalism man exploits man. Under Socialism the reverse is true.”-author unknown. The Poles got Stalin, we picked a new president. We got the lesser of the two distortions.
I’ll take it. For the time being, rebalance your portfolio (or what is left of it if you didn’t get out of the way of this meltdown) to reflect the present and please, try to find something that rhymes with 2012.
Trent Tucker
author Wall Street Dancers
www.strategicbookpubli....

2008 Dec 28 03:06 PM