Lately, the idea of dollar cost averaging into excellent companies has been on my mind. With companies like Exxon Mobil (XOM), Procter & Gamble (PG) and Johnson & Johnson (JNJ) allowing you to have money taken out of your checking account each month so that you can invest in the shares at no cost, you can easily put yourself in the position to build a sizable stake in an excellent company over time.
It's so easy. It's so straightforward. There aren't many clear and straightforward paths to building wealth out there, but one of them is to identify those "no brainer" stocks and let the Holy Trinity of wealth creation do its thing: combine regular cash purchases with reinvested dividends with a dividend payout ratio that grows each year.
Exxon has been hiking dividends for three decades, and going back to its Standard Oil days, the company has been paying out a dividend since the late 1800s. Both Procter & Gamble and Johnson & Johnson have been raising dividends for over half a century. Think about all the stuff that has happened since then. Cold War. Vietnam. A nasty recession in 1973-1974. High inflation. High interest rates. The collapse of the Soviet Union. 9/11. Trillion dollar deficits. Rising unemployment. All that stuff happened, and it turns out that people still use Tide Laundry detergent (among two dozen other $1 billion brands at Procter & Gamble) and Tylenol (among over a dozen other billion dollar brands at Johnson & Johnson).
People cite all of these terrible things that happen (and yes, terrible things do happen), but it has not been enough to stop any of these companies from being profitable. In fact, they are so strong and profitable that they can freely give away a large chunk of their profits to shareholders in the form of cash dividends each year and still maintain their competitive positions and grow. What does that tell you about the long-term business models of these companies?
Here is what we can do to make the strategy more interesting: there is nothing to stop us from manually making a lump-sum investment into these companies alongside our dollar cost averaging plans in a way that greatly skews our cost basis.
Even though I try my absolute best to research a stock thoroughly before I buy it, it is really the act of owning the company that makes me the most familiar with it. There is a difference between, say, owning Chevron (CVX) stock for five years and following it for five years. If you buy shares of Chevron stock each month, you are going to be reading the latest storyline developments affecting the company and you are going to get loose ideas of the company's trading range as it relates to your purchase price each month.
This familiarity is something that you can use to your advantage. In 2013, Exxon has traded between $85.00 and $93.67. In 2012, the company traded between $77 and $93. In 2011, the company traded between $67 and $88.
Right now, the company trades at $89.65. Let's say you are humming along, putting $100 into Exxon each month. At some point in the next year or so, you see that the price of Exxon falls to $70 per share. Because of your familiarity with the stock's trading history, you can have the foresight to make a lump sum contribution at that time.
It can be a great way to lower the cost basis of your investment in an excellent company. Picture this. You've been investing $100 per month into Exxon for a year, and you bought 14 shares at a cost basis of $85.71. The price of oil and natural gas takes a tumble, and suddenly, you see an opportunity to buy Exxon at $77 per share. You write out a check to buy $2,310 worth of Exxon stock, netting you 30 shares (and there are no frictional costs, as Exxon's DRIP program is free).
Suddenly, the cost basis of your dollar cost averaging program took a nice little turn. Instead of having a cost basis of $85.71, you now have a cost basis of $79.77 per share. If you make lump sum investing a part of your dollar cost averaging program, you can seize opportunities to lower your cost basis and add a "value investing" component that is not traditionally associated with DRIP investing.
Usually, dollar cost averaging programs are billed as a way to gradually acquire shares in a long-term holding over time. That is certainly true. But since we are not mindless, we can make it more than that. When we buy shares of a company every month, we cannot help but come familiar with the typical price points of our purchases. That makes it easy to recognize dips, declines, corrections, etc. As a regular purchaser of the stock, you have a bird's eye view. If you mix lump sum investing with dollar cost averaging, you can get the best of both worlds by combining value investing with the gradual accumulation of excellent companies.