DRIPs and C-Ks
by Rob Landley
Austin, TX (July 23, 1998) -- For Fools investing on a limited budget, especially those just starting out, I'd like to make the case for using Dividend Reinvestment Plans (DRIPs) to buy into Cash-King stocks. And for parents looking to get their kids started -- setting up a custodial account where they can DRIP portions of their allowance into the market for the long haul makes much Foolish sense.
Let's talk some specifics:
A Dividend Reinvestment Plan provides a way to buy stock without going through a broker. Many of our nation's larger companies that pay a dividend offer their shareholders the option of automatically using the dividend money to buy more shares of the company's stock.
The real beauty of DRIPs is that once the company has this stock-purchasing mechanism in place, it generally lets participating shareholders directly contribute additional amounts of their own money via "Optional Cash Payments." This literally allows you to mail in a check to buy perhaps one third of a share of stock, whenever you can spare the dough.
You can't do that through a traditional stockbroker because you can't buy fractional shares on the open market. Even if you could, the commissions you'd pay to the brokerage would demolish your account. For this reason, DRIPs and discount brokering are changing Wall Street. With every passing year, the barriers to entry into the greatest wealth creating opportunity this century are dropping. They never should have been so high -- unless the thought of stockbroker Winchester Manfred IV gutting accounts for commissions and polishing his BMW on Fridays makes you feel that all's right with the world.
It certainly doesn't make me feel good!
Back to DRIPs. The best DRIP plans have no fees, invest Optional Cash Payments each month (rather than waiting for the paying period for dividends to roll around), and they allow fairly small cash payments -- as little as $10 or $25 at a time.
Among the most investor-friendly DRIPs are a few companies in our Cash-King Portfolio: Coke and Intel. Not all DRIP plans are this friendly. Some don't invest the cash payments until the next dividend is issued. Some have minimum investment demands so high that you should just use a discount broker. Some demand fees per investment, like IBM, which charges a $5 fee per cash payment. That's still better than a broker's commission, but amounts to a 10% cut of a $50 investment. Kinda defeats the purpose.
Since DRIPs are a service to existing shareholders, to participate in a DRIP you have to already own at least one share of the company. Some companies allow you to buy that first share directly from them, but usually you'll have to buy it from a broker. You then request that the "stock certificate" be held in your name and transferred to you. Warning: Some brokers charge for this. Datek charges $50 to issue a stock certificate -- naturally, they don't want to encourage DRIPping.
One conventional brokerage house, Dean Witter, provides a very good deal to investors. For your first share, they cap their commission at 10% of the price of your purchase. That means that if you're buying a $75 of stock, they cap your commission cost at $7.50. For a $25 stock, it naturally drops to $2.50. There are a variety of DRIP servicers. You got Dean Witter; First Chicago has a great setup for investors; and the DRIP Portfolio here at The Fool uses The MoneyPaper.
Once you've got your stock certificate, it's up, up, and away. You can add new money at your leisure. Essentially, you'll be banking with this company... and expecting much better annual returns than a passbook savings account offers.
There are some disadvantages, though: 1) DRIPs are an administrative burden and 2) they tie you down into fairly long-term ownership of a specific stock. To buy, you have to get a stock certificate, then file DRIP enrollment forms, then make regular cash payments. And if you want to sell out your position in the company, you'll have to fill out a form to terminate your DRIP. You can't get into and out of a DRIP plan very easily. And there's a fair amount of stuff to keep track of.
The final and obvious disadvantage of DRIPs, from a Cash-King investing perspective, is that companies have to pay a dividend in order to have a DRIP. Some of the best companies we've discussed in the Cash-King message boards, such as Cisco, Dell, and (grumble) Microsoft, don't pay dividends, and thus don't have any DRIPs. There are three reasons that we don't like dividends, and that many of our CK companies don't pay them.
1) Dividends get double-taxed -- taxed as income for the corporation, then taxed as income for the individual. 2) With markets broadening around the world, we'd prefer that our companies were investing in their operational expansion. 3) Given the first two, we prefer to see our companies buying back their own shares rather than paying out dividends. Share buybacks feature no double taxes, and make an important statement about our companies' faith in themselves: "We want to own more of us."
For two reasons -- the administration costs and the focus on dividends -- we're not using DRIPs in the Cash-King portfolio. As we're investing $2,000 at a time, saving on the tiny one-time commissions from online brokers doesn't make much sense. Published discounter commission rates are down between $5-$10 in Fooldom today. I believe that anyone making investments of greater than $750 a pop is best served by the online discounters. But for the college student digging $25 a month out of spare change found under sofa cushions, DRIPs are absolutely ideal.
If you have any more questions about this, there are two Cash-King message boards. There are also two message boards devoted entirely to DRIPs. There's even a Foolish real-money portfolio around here based on DRIP investing, which operates along principles very similar to Cash-King investing.
- Rob Landley
Day Month Year History C-K -2.34% 2.70% 17.12% 17.12% S&P: -2.09% 0.52% 13.83% 13.83% NASDAQ: -1.75% 2.14% 17.08% 17.08% Cash-King Stocks Rec'd # Security In At Now Change 2/3/98 24 Microsoft 78.27 113.00 44.37% 2/3/98 22 Pfizer 82.30 111.56 35.56% 2/27/98 27 Coca-Cola 69.11 83.25 20.47% 5/1/98 37 Gap Inc. 51.09 59.25 15.97% 6/23/98 23 Cisco Syst 86.35 99.13 14.80% 2/6/98 56 T. Rowe Pr 33.67 38.31 13.78% 5/26/98 18 American E 104.07 108.81 4.56% 2/13/98 22 Intel 84.67 82.56 -2.49% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 63.15 85.00 34.61% 3/12/98 20 Exxon 64.34 70.13 9.00% 3/12/98 15 Chevron 83.34 81.56 -2.14% 3/12/98 17 General Mo 72.41 70.44 -2.72% Cash-King Stocks Rec'd # Security In At Value Change 5/26/98 18 American E 1873.20 1958.63 $85.43 2/3/98 24 Microsoft 1878.45 2712.00 $833.55 2/3/98 22 Pfizer 1810.58 2454.38 $643.80 2/27/98 27 Coca-Cola 1865.89 2247.75 $381.86 5/1/98 37 Gap Inc. 1890.33 2192.25 $301.92 6/23/98 23 Cisco Syst 1985.95 2279.88 $293.93 2/6/98 56 T. Rowe Pr 1885.70 2145.50 $259.80 2/13/98 22 Intel 1862.83 1816.38 -$46.45 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 15 Chevron 1250.14 1223.44 -$26.70 3/12/98 20 Eastman Ko 1262.95 1700.00 $437.05 3/12/98 20 Exxon 1286.70 1402.50 $115.80 3/12/98 17 General Mo 1230.89 1197.44 -$33.45 CASH $94.76 TOTAL $23424.89 *The year for the S&P and Nasdaq will be as of 02/03/98