A Financial Revolution 

December 17, 2005
The Power of a DRIP

A little over a decade ago I made my first foray into investing in individual stocks. Those first investments were made through dividend reinvestment plans (DRIPs). A number of companies offer these plans to their shareholders. As the name implies, dividends paid by the company are automatically reinvested in more shares of the company's stock. Some companies even provide a discount on the new shares.

Many of the plans also offer investors the opportunity to purchase additional shares directly at no-cost or for minimal fees. This was the perfect tool for my entry into the investor class. It allowed me to put an extra $100 a month into the stocks, much like I did with my mutual funds.

After reading Peter Lynch's One Up on Wall Street, I decided to follow his instructions and focus on what I knew. In 1995 with $2,000 in my pocket, I purchased stock in Home Depot (HD) and my local gas company - Piedmont Natural Gas (PNY) - through their DRIPs. Both turned out to be very good investment not only because of price appreciation, but also because of the DRIP. Take PNY as an example: not only did the stock pay a 9% dividend at the time I purchased it, PNY offered a 5% discount on all shares purchased with reinvested dividends! An investment of $1,000 in PNY's DRIP in January 1996 would be worth $6,793 today, nearly $1,800 more than if dividends were not reinvested (see table.)

The non-DRIP results don't include the potential return from the dividends, but the table offers a sense of the power of DRIPs.

There is another benefit of this approach: the reinvested dividends buy more shares that then earn dividends. That initial $1,000 investment would now generate $253 in dividends a year (vs. $144 w/out reinvestment.)

Home Depot on the other hand had only a 0.5% yield. As a result, $1,000 invested in HD's DRIP in January 1996 would now be worth $4,508, only $62 more than if if dividends were not reinvested in the stock.

The lesson I learned is that DRIPs, especially those from companies that pay a decent dividend, are a great way to get started investing in individual companies. As an added bonus, it's a great way to save on brokerage fees if you invest a relatively small amount on a regular basis.

A couple years after making those first investments (and landing a job!), I graduated to a full-fledged brokerage account and forgot about the power of DRIPs. Recently, however, I noticed that my brokerage will automatically reinvest dividends in any common stock at no cost. I called the next morning and enrolled. Now I just need to wait for the next dividend season!

Additional Resources

Categories: [Dividends] [Investing]

Anonymous Diffus said...

DRIPs are great in theory, and in many cases, in practice. I can think of two potential problems. Both, however, can be obviated by keeping detailed and accurate recprds of all DRIP acquisitions.

First, you need to be sure and keep excellent records so that, when the shares are disposed of, you have can determine your cost basis accurately for tax purposes.

Second, unless you have accurate records, if your stock splits or spins off, you're in for a doozy of a time figuring out what you have left and how much you paid for it.

Computerization and Internet access make these less of an issue now, but I and my mother were in AT&T's DRIP for many, many years. During that time, AT&T spun off several subsidiaries, and, not having kept detailed records, my mother and I had absolutely no idea of what the cost basis of either the spun-off shares or of our remaining AT&T investments were.

12/21/2005 9:04 PM  

Blogger Jeremy said...

Thanks Diffus. Those are excellent points. I used MS Money to keep track of my DRIPs and it was pretty simple. The only complexity I encountered, however, was an occasional split.

12/23/2005 1:13 AM  

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