Education: Growth & Income Investing

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Reinvesting Your Dividends

For those requiring an additional stream of income, dividends can be quite beneficial However, if this cash flow is simply serving as an added perk—that is, you can live without it at this point in your life—you should consider a dividend reinvestment plan (DRIP).

Not all companies offer DRIPs but for those that do, they can provide investors with a number of benefits. How does purchasing stocks without having to pay a commission sound? Too good to be true? There may be such a thing as a free lunch after all…

DRIP, DRIP, DRIP

No, that’s not the sound of a leaky faucet. While one of those can create quite a headache, dividend reinvestment plans provide quite the contrary, and can be quite advantageous. But before we jump into the potential pluses, let’s define exactly what a DRIP is.

If an investor is allowed to participate in a company’s DRIP, he or she will no longer receive a dividend when that particular company issues one. But rather, as the name implies, the dividend is reinvested and the stockholder receives additional shares of the company’s stock as a result. These plans can serve as excellent ways to increase the value of your investment.

Enrolling in a DRIP is actually quite simple. Once you have purchased a particular stock, you can contact the company’s investor relations department to inquire about its availability. If such a plan is an option, filling out the required paperwork should only take but a few minutes. Investors can choose from around 1,000 companies providing this investment opportunity.

Not All DRIPs Are Created Equal

It is important to know that not all DRIPs are run in the same manner. DRIPs can be broken down into three different types:

Company-run DRIP

This pertains to a dividend reinvestment plan that is run by the company that offers it. Company-run DRIPs are simply administered from corporate headquarters, usually by the investor relations department.

Third party-run DRIP

For those companies that do not have the resources available to run their own DRIP, they can elect to go with a third party financial institution, also commonly referred to as a transfer agent, to run the plan. This organization will act on behalf of the company offering the DRIP. This can sometimes be a more cost-effective course of action for a company to take.

Brokerage-run DRIP

DRIPs can also be set up through a brokerage, even if the company you are investing in does not currently offer such a plan.

Advantages of DRIPs

1. When an investor makes a purchase through a dividend reinvestment program, they are typically subject to little or no commission. Any business that you can conduct without any type of fee is a definite perk.

2. If an investor does not want 100% of a company’s dividend payments reinvested, a limited number of shares can be registered, leaving the remainder to continue to provide cash dividends. Everyone loves flexibility.

3. Most DRIP participants need not worry about having enough proceeds to purchase shares in whole increments. DRIPs allow investors to purchase fractional shares.

4. DRIPs “force” participants to invest small amounts of money on a regular basis. This will work to your advantage over the long term.

5. Some companies have DRIPs that allow participants to purchase their stock at a discount to its current market price. These discounts can be as low as 1% and may be as high as 10%.

Conclusion

Needless to say, just because a company offers a DRIP, doesn't automatically qualify it as a good investment. It needs to be fundamentally sound as well. The Zacks Rank is a time-tested way to identify fundamentally-strong companies. This quantitative model uses four factors related to earnings estimates to classify stocks into five groups, ranging from “Strong Buy” to “Strong Sell.” (Learn more about the Zacks Rank). If you can find stocks with healthy Zacks Ranks that also offer DRIPs, you are in for a nice ride.