I'll let you in on a little secret: Not a single business day goes by where I don't take a peek at my taxable investment account to see if I have any incoming dividends that day. Very few things in life provide the pleasure of seeing a fresh, sizable dividend come streaming in, adding to the amount of capital in my investment account. On the weekends, when dividends aren't distributed, I often check to see when my next ex-dividend, record date and pay dates are to stay ahead of the game.
You see, when it really comes down to it, I'm a dividend junkie.
Just to give you a little insight, I've been investing faithfully in dividend-paying value stocks for about three years now, and I'm addicted. Often times I'll plan what I want to buy with my dividends weeks before my balance has accrued enough capital to make my purchase worth it. I'll comb through financial statements, dividend yields, payout ratios, assets, debt and the like, in order to choose a reliable company that will hopefully have my best interest in mind by paying me juicy dividends for decades to come.
The first fund I ever purchased was SPY and I literally jumped up and down after reinvesting my first $3.23 dividend -- buying an additional 0.036 shares -- back in 2009. Since this exciting day, I've received literally hundreds of dividends, and the stream continues to grow year after year as I contribute as much fresh capital to my account as I can, and the companies I choose go on with raising dividend payments year after year. Last year I received $1,337 in dividends and I suspect I'll break $1,500 this year if I continue with my current plan.
The start of 2012 marked an exciting time in my investing strategy because I changed my reinvestment methods a little bit. Instead of faithfully reinvesting my dividend in the same company which paid it out to me in the form of a Dividend Reinvestment Plan (DRIP), I decided to begin taking my dividends in the form of a cash payout, building them up with the help of new, fresh capital and making strategic purchases with one stock which I believe to be undervalued, rather than reinvesting the capital into the same dividend stock.
Why I believe this method is superior
Let's face it, whether you reinvest your Visa (V) dividend in Visa or choose to take the meager dividend yield and purchase shares of a dividend aristocrat with greater yields, such as Johnson & Johnson (JNJ), you're still "reinvesting" your income stream in a similar way. In the above example; however, it's clear that V's dividend yield, currently hovering around 0.85%, is meager when standing up the likes of JNJ's attractive 3.5% yield. I feel that I'll be able to witness the power of compounding occur in a more timely fashion when reinvesting my capital into stocks with higher yields while foregoing a DRIP.
Another reason I prefer this method, which could be considered controversial by some, is that I truly feel more capable of investing my dividends in companies with better valuations than the dollar cost averaging (DCA) style which takes place with a DRIP. In other words, when companies are trading at historically high valuations, using history as a guide, it would be sensible to hang onto this capital until valuations improve-- or deploy this money into stocks with more reasonable valuations in order to prevent purchasing shares with lofty valuations. Again, this method assumes I have superhuman stock picking abilities -- which I am reasonable enough to know I do not possess. However, using P/E ratios as a guide, I believe it would be reasonable to invest in a company with a history of a P/E of 15 currently sporting a P/E of 10 rather than purchase shares in a company trading with an unreasonably high historical P/E ratio. The risk versus reward scenario seems appropriate to me in this situation.
The flip side of this argument
I'm sure many of you smart readers out there will argue this method would require an investor to take on more risk. I would have to agree with you there, but in addition to adding systemic risk, there are a few other reasons why you could argue a DRIP is superior.
First off, DRIPs prevent trading fees, as the dividends are reinvested at no cost to the investor. When collecting cash dividends, building them up and purchasing new shares, trading fees are incurred. This should be taken into consideration. Additionally, as I mentioned above, it's conceivable that my ability to pick stocks may be inferior to the DCA-type style DRIPs provide. DRIPs have been shown to be an incredible way to build long-term wealth. Lastly, if an investor is careless, they may be temped to spend their dividends on things other than stocks, or possibly even purchase growth stocks instead which -- not while necessarily being a bad strategy -- could refute the argument that compounding would be more significant by foregoing the DRIP and reinvesting the dividends in higher yields.
Now that you have the gist of my strategy, here are three dividend stocks I faithfully collect cash dividends from but choose not to reinvest:
1. Visa Inc. . Again, don't get me wrong, I simply love this stock but the meager 0.85% yield Visa provides doesn't give me hope in the long-term power of compounding. I would much rather reinvest this capital in a stock with a 3% higher yield or better.
2. Church & Dwight Co. (CHD). I've been simply amazed with CHD's ability to grow its share price over the last few years and have seen my balance grow considerably. However, with a moderate 1.5% dividend yield, I believe I can find better ways for reinvestment.
3. Dover Corporation (DOV). Despite being an incredible stock and one I plan on holding for many years, I much prefer to deploy DOV's 2.1% dividend into higher yields in my investment account.
Here are two stocks I absolutely love which I continue to purchase with my cash dividends with better yields:
1. General Electric Company (GE). Dividend investors were literally shocked when GE announced it would be lowering its dividend from $0.31 to $0.10 back in 2009. But GE recently raised its dividend from $0.15 a share to $0.17 a share back in December 2011, a 13.3% increase, which builds my confidence in the company's ability to reward shareholders. GE expects revenues to grow in double digit figures in 2012 and and with a moderate payout ratio of 48%, I suspect GE will be able to continue to raise its dividend at an attractive rate for the foreseeable future. GE's 3.6% dividend fuels the power of compounding better than dividend offerers with yields of 2.1% or lower.
2. Waste Management, Inc. (WM). Being an industry leader in waste services has its advantages. Among the many, many services it provides, WM also provides shareholders an incredible service in the form of a monster dividend. In many ways, it behaves similarly to a utility stock (low beta, strong dividend, relatively high payout ratio, strong earnings, a sizable amount of debt) and being an investor looking for high yields to assist in compounding, WM's 4% dividend yield catches my attention much better than lower dividend yields. WM has been raising its dividend every year since 2004 and I look forward to further dividend hikes down the line.
At the end of the day the most important aspect of the reinvestment of dividends is actually using the capital to repurchase shares of stock. The debate will rage on whether DRIP-style reinvestment or my above referenced method is superior, but for the time being, I'll continue to reinvest every single penny received from my holdings into high yielding stocks in order to take advantage of the magical power of compounding. Feel free to check on me in 20 years to see how things are going.