Are Drips Worth It?

This article originally appeared on The DIV-Net September 26, 2008.

The abbreviation DRIP stands for dividend reinvestment plans. Drips are a nice low cost way to purchase dividend stocks and build a stock portfolio. These programs allow investors to purchase shares in two ways either through reinvesting dividends or with optional cash payments that can be sent to the companies you want to invest in. One benefit of drips is that they allow dividend reinvestment in partial shares. Another benefit of other drips is that some allow reinvesting your dividends by purchasing shares at a discount to the market price. Two such companies that I am aware of that do this are ACAS and NNN. Below you can also check my analysis of ACAS and NNN.

One of the issues with drips is that in order to participate in the DRIP you must already have purchased one share of the company stock. Some companies have overcome that hurdle for shareholders by letting people make a direct purchase in their stock. Stocks like GE or XOM are good examples of direct purchase plans with reinvestment plans.

Another problem with drips however is that you do not have the execution speed like you do when you purchase shares through a broker. If you want to buy or sell shares at the current market price, you can’t do it. In addition to that, despite the fact most drip plans allow charge low or no fees for purchasing additional shares or reinvesting your dividends, most drips have high initial set-up fees.

Another issue that I have with drips is availability. Not all companies offer drips, so you might have to use a stock broker after all.

From a tax perspective drip Investors must track their cost of shares to be used to calculate capital gains tax when shares are sold. In addition to that very few dividend reinvestment plans allow you to hold stocks in an IRA DRIP, which allows for a tax free compounding of your dividends. Examples of non-taxable dividend reinvestment plans include XOM, which offers both traditional and ROTH IRA dividend reinvestment plans.

From a diversification perspective a drip investor has to enroll in as many plans as the number of individual companies he or she plans to invest in. This would a be very inefficient way to keep track of your investments.

The main positive of drips is the fact that one can start with a small amount of money, typically enough to buy one share of stock. DRIPs also allow novice investors to dollar cost average small amounts of money each month without getting killed on the brokerage commissions. The automatic dividend reinvestment comes in handy as if allows you to simply set up your drip with a company and then its all automatically invested into additional shares, while you take full advantage of the power of compounding.

So what is a good alternative to dividend reinvestment plans?

Most brokers allow you to purchase stock in any company that is traded on the NYSE, NASDAQ, AMEX and the OTC markets by charging you a small commission for that. After that however most brokerages do not charge any additional fees if you decide to reinvest your dividends. Some brokers like Sharebuilder allow you to reinvest your dividend by purchasing fractional shares, which accelerates the power of compounding in your favor. In addition to that, I would prefer having my entire dividend portfolio concentrated in one or two places as opposed to having it spread out among thirty different reinvestment plans. Most brokers also keep much more detailed information of your transactions activity in one place, compared to drip plans, which definitely helps during tax time.

And last but not least it is much easier to open a retirement account at a stock broker for a small fee, without being limited to the small number of drips inside an IRA out there.

DivGuy and Get Rich Slowly have both published some insightful articles on DRIPs. Check them out.

Relevant Posts:

- Why dividends?
- Why dividends matter?
- My Dividend Growth Plan - Strategy
- When to sell your dividend stocks? Part 2

Chevron Corporation (CVX) Dividend Stock Analysis

Chevron Corporation operates as an integrated energy company worldwide. The company’s organized into several segments including Petroleum operations, chemical operations coal mining, power generation, insurance, and real estate activities.

Chevron is a dividend achiever as well as a component of the S&P 500 and Dow Jones Industrials indexes. It has been increasing its dividends for the past 20 consecutive years. From the end of 1999 up until September 2008 this dividend stock has delivered an annual average total return of 11.10 % to its shareholders. The stock has lost about four percent of its value so far in 2008.

At the same time company has managed to deliver a 27.00% average annual increase in its EPS since 1999, supported by the commodities bull market of the past decade.

The ROE fluctuated between 5% and 35%. The past couple of years have been characterized by higher returns on equity.

Annual dividend payments have increased over the past 10 years by an average of 7.10% annually, which is much lower than the growth in EPS. Using the rule of 72 a 7% growth in dividends translates into the dividend payment doubling almost every ten years. If we look at historical data, going as far back as 1988, CVX has indeed managed to double its dividend payment every ten years on average.

It’s interesting to note that both XOM and CVX have not kept pace with the EPS increases by raising their dividends accordingly. Instead those oil behemoths have decided to make stock buybacks, which are not as reliable as dividend payments over the long run. I think that CVX and XOM management probably have not increased dividends as fast as earnings because they consider the current commodities boom to be of short term nature.

If we invested $100,000 in CVX on December 31, 1998 we would have been able to purchase 2411 shares (Adjusted for a 2:1 stock split in 2004). In February 1999 your quarterly dividend income would have been $735. If you kept reinvesting the dividends though instead of spending them, your quarterly dividend income would have risen to $2115 by August 2008. For a period of 10 years, your quarterly dividend income would have increased by 113%. If you reinvested it though, your quarterly dividend income would have increased by 188%.

The dividend payout has remained below 50% after 2003. Before that the payout had followed the wide fluctuations in earnings rising above 100% on several occasions. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

CVX does look attractively valued with its low price/earnings multiple of 9, low DPR as well as attractive yield at 3%. If I had to choose between XOM and CVX, the latter would be the obvious candidate for me. I will look forward to entering a position into this stock on dips.

Disclosure: I do not own shares of CVX

Relevant Articles:

- BP (BP) Stock Dividend Analysis

- XOM Dividend Analysis

- Emerson Electric (EMR) Dividend Analysis

- Wal-Mart Dividend Analysis

- Free Magazines

Which Bank will be next? Follow the dividend cuts

I received a lot of e-mails from subscribers on Monday after the collapse of Wachovia, asking me which bank I believe will be the next to fail. Most investors are afraid they will wake up next Monday morning with a worthless financial stock, whose deposits have been sold to another institution.

I think that the answer to that question is to simply follow the money. Most of the financial institutions which ended up with stock prices rapidly approaching gravity were in terrible financial condition and as a result their management scrambled to find ways to fund the ongoing operations and cut expenses to the bone. One of the most difficult decisions that most boards had to make was cut the dividends.

Typically most US companies pride themselves for having an uninterrupted record of paying dividends or even better, a long period of uninterrupted increases in their annual payments to stockholders. Thus cutting the dividends to shareholders is usually one of the last resorts to action.

If you look at the records of the financial institutions in the S&P 500 that cut their payments this year, you will find an interesting pattern of dividend cuts and then massive failures. Examples like this include FNM, FRE, LEH, WB and WM. In most cases the dividend cut gave shareholders a warning signal at least several months before the failure. Just for the record this strategy isn’t foolproof so don’t bet the bank on it – there will surely be financials which cut their dividends and most probably prosper in the coming good times. It would be interesting to note how the companies in this list perform over the next few years.

Name	Dividend Cut	Type	Symbol	New	Old	Cut	Sector	Notes
Ambac Financial Group	JAN	DECREASE	ABK	0.28	0.84	-66.67%	Financials
Citigroup Inc	JAN	DECREASE	C	1.28	2.16	-40.74%	Financials
First Horizon Natl	JAN	DECREASE	FHN	0.8	1.8	-55.56%	Financials
MBIA Inc	JAN	DECREASE	MBI	0.52	1.36	-61.76%	Financials
Natl City Corp	JAN	DECREASE	NCC	0.84	1.64	-48.78%	Financials
Sovereign Bancorp	JAN	SUSPENSION	SOV	0	0.32	-100%	Financials
MBIA Inc	FEB	SUSPENSION	MBI	0	0.52	-100%	Financials
Ambac Financial Group	MAR	DECREASE	ABK	0.04	0.28	-85.71%	Financials
CIT Group	APR	DECREASE	CIT	0.4	1	-60%	Financials
Huntington Bancshares	APR	DECREASE	HBAN	0.53	1.06	-50%	Financials
Natl City Corp	APR	DECREASE	NCC	0.04	0.84	-95.24%	Financials
Wachovia Corp	APR	DECREASE	WB	1.5	2.56	-41.41%	Financials	Failed
Washington Mutual	APR	DECREASE	WM	0.04	0.6	-93.33%	Financials	Failed
Federal Natl Mtge	MAY	DECREASE	FNM	1	1.4	-28.57%	Financials	Failed
Fifth Third Bancorp	JUN	DECREASE	FITB	0.6	1.76	-65.91%	Financials
KeyCorp	JUN	DECREASE	KEY	0.75	1.5	-50%	Financials
Regions Financial	JUL	DECREASE	RF	0.4	1.52	-73.68%	Financials
Wachovia Corp	JUL	DECREASE	WB	0.2	1.5	-86.67%	Financials
First Horizon Natl	JUL	SUSPENSION	FHN	0	0.8	-100%	Financials
Federal Home Loan	AUG	DECREASE	FRE	0.2	1	-80%	Financials	Failed
Amer Intl Group	SEP	SUSPENSION	AIG	0	0.88	-100%	Financials
Comerica Inc	SEP	DECREASE	CMA	1.32	2.64	-50%	Financials
Federal Home Loan	SEP	SUSPENSION	FRE	0	1	-100%	Financials
Federal Natl Mtge	SEP	SUSPENSION	FNM	0	0.2	-100%	Financials
Lehman Br Holdings	SEP	SUSPENSION	LEH	0.05	0.68	-92.65%	Financials	Failed
Lehman Br Holdings	SEP	DECREASE	LEH	0	0.05	-100%	Financials

So should you be worried about the next bank failure? I think that as long as your portfolio is well diversified you shouldn’t worry too much about day to day news but focus on the big picture and your long term financial goals. Historically it has paid off well to pick up distressed assets at bargain prices during bear markets. In addition to that dollar cost averaging your way into a position is the perfect strategy in a bear market. Check this chart out for the average durations of previous bear markets for reference as well.

Full Disclosure: I do not have any positions in the companies mentioned in this article.

Relevant Articles:

- Dollar Cost Averaging
- Average Durations of Previous Bear Markets
- My Dividend Growth Plan - Diversification
- When to sell your dividend stocks? Part 2