I have probably beaten the subject of DRiPs to death in my Fribbles and message board posts. I still find, however, that many people don't know a lot about this method of investing. So, let's beat this carcass a little bit more. Ow! A buzzard just bit me! Get away! Stupid bird... OK, here goes.
What is a DRiP? It is a Dividend Reinvestment Plan. It's not a really good name, because it insinuates you are only investing dividends into more of the stock you are holding. I would use Optional Cash Purchase Plan, but try to pronounce OCuPP and you see why the word DRiP is used. Generally, a DRiP plan allows you to buy one share of the stock from a broker, and then buy additional shares from the company itself. Usually, you pay no commissions, and a minor transaction cost.
Do all companies have DRiPs? No. Making it harder to keep this Fribble to one page, they all have different plans. Some make you buy 10 shares of stock from a broker. Some sell you the initial shares directly (like Texaco, Exxon, and McDonald's). Some have outlandish transaction costs, and some have no transaction costs. Fortunately, a Web site was created by Carnegie Mellon University which summarizes most DRiP plans, and how to get into each one. Just click on Dividend Re-Investment Program Guide and you're there.
Investing in DRiPs is really for the long term. It allows you to send in a fixed amount on a regular basis (I go for monthly), which takes advantage of dollar-cost averaging. That way, if the stock price is a bit overvalued, you buy fewer shares. If Elaine What's-Her-Name predicts the market is going to tank, and people sell your company's stock in a panic, you buy more shares. The big problem can be selling the stock. If it comes out that the CFO has run off to Argentina with his wife's sister and the company's entire treasury, you can't unload your position quickly. However, some plans allow you to sell within 24 hours. The ones that use First Chicago Trust Company as a transfer agent generally do (Coca Cola and Johnson and Johnson, for example).
How do you chose a company for a DRiP? Look for consistent growth over the past several years. The S&P Stock Guide is a good place to start (you can get it free from almost any broker or call 1-800-221-5277). Look for regular earnings and dividend growth. Next, check out First Call or Zacks to see what the future earnings growth is expected to be. I would eliminate anything with less than a 15% five-year growth rate (with some exceptions) .
From here, you need to research the heck out of your company. Take all the steps I outlined in my last Fribble. You are in for the long term, and you are buying a business. Like buying any business, you need to understand what you are doing. Fortunately, since you are using dollar-cost averaging, you don't have to worry that much if the business is a bit overvalued right now.
Some investors constantly track their DRiPs, and when the companies are overvalued, they send no money. They send more as the companies get undervalued. That is an excellent way to do things, but I'm not that disciplined. I am in plans that take the money out of my bank account every month on a regular basis. The dollar-cost averaging tends to even out any inefficiencies in the stock price. However, if you can follow the companies and invest only when their stock price warrants it, you'll do much better than I do.
What about diversification? That is a serious problem if you have a short time horizon. In such cases, I would invest in an index fund like Vanguard's Index 500 Fund and skip the DRiPs. Over a long period, the diversification can be solved by accumulating a satisfactory amount in a given DRiP, and then moving on to another company's plan. In time you can build up a diversified set of holdings. Also, in the beginning it is a good idea to invest in companies that are already fairly diversified like Proctor and Gamble and General Electric. That also protects you somewhat from economic cycles and changes in industry performance.
DRiP investing allows you to invest small amounts at a time, with the advantage of dollar-cost averaging, and not paying commissions. There is much more about DRiP investing that space won't let me write about here. Chuck Carlson, aka MF DRIPS, has written a number of excellent books on the subject. I suggest you check them out in the FoolMart, or your local library. While this type of investing may not be suitable for all, it is a good choice for the small investor with a long-term horizon. I don't think I'll ever be able to let this subject lie in peace; that buzzard will just have to feast on the O.J. trial.
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