Wednesday, July 22, 2009

Reinvest Dividends Selectively

Reinvested dividends have contributed most all of the stock markets total returns over large periods of time. Some dividend investors automatically reinvest their distributions over time, which leads to compounding of their income and principal. Others do not reinvest automatically and instead wait for distributions to accumulate before adding onto existing positions or initiating new ones.

Dividends could be either sitting there or get reinvested. The beauty of dividends is that it is under the discretion of the individual investor to purchase more stock, buy equity in a different company/investment or spend it another way.

I do reinvest only a portion of my stocks directly; most other times however I let my dividends accumulate and I either re-invest in the same stock/s or in new stocks that have been on my watchlist.

It is important to keep costs as low as possible when allocating dividend income for reinvestment. Thus it is wise to open a discount brokerage account at places such as Zecco, Tradeking, Scottrade or Sharebuilder, which have relatively easy to use platforms and low commissions for stock trades.

I don't typically look at dividend reinvestment on an issue-by-issue basis, but through the lenses of a diversified dividend portfolio. If I had received enough dividends to purchase an additional position and I had to choose between investing in the energy company Chevron (CVX) or the consumer staple Johnson & Johnson (JNJ) I would most likely reinvest my distributions into the energy sector if I were under allocated there.I also do not reinvest dividends if the companies I own do not pass my entry criteria at the time or companies which are way off base my entry criteria. I am a little more relaxed when it comes to reinvesting dividends versus initiating a position in a stock. I could reinvest dividends even if the payout ratio increased beyond 50% to say 60% or even if the current yield is about 2.70% and not 3%. I am pretty strict however about not paying more than 20 times earnings on a given stock. This is the main reason why I automatically reinvest only some of my position in Realty Income (O).

Some attractively valued stocks for dividend reinvestment right now include:

Pepsi Co (PEP) analysis
Clorox (CLX) analysis

Automated Data Processing (ADP) analysis
Kinder Morgan (KMP) analysis

Sysco Corp (SYY) analysis
Selective dividend reinvestment avoids purchasing overpriced shares with your monthly or quarterly distributions, which could be a real drag on total returns and portfolio income. It is important however not to get overallocated in a particular stock or group of stocks as well, as diversification should be also taken in consideration when dividends are being reinvested.

Full Disclosure: Long all stocks mentioned above

Relevant Articles:

- Zecco Online Discount Stock Brokerage Review
- Johnson & Johnson - a solid dividend aristocrat
- Dividend Portfolio Investing for monthly income
- Why should companies pay out dividends?

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