DRIP PORTFOLIO
The Time Dividend
The Contrarian Case for Drips

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By Brian Graney (TMF Panic)

ALEXANDRIA, VA (Jan. 7, 2000) -- Over the next few weeks, Jeff and I will be entertaining suggestions from Fools of all shapes and sizes about our next industry study. So far, the Drip message boards have yielded some interesting ideas, with sectors such as biotechnology and wireless communications most frequently recommended.

While we are far from deciding the subject of our next focus area, now may be a good time to guide the discussion with some perspective. We relish the idea of being contrarian investors, so it should not come as much of a surprise if what follows sounds strange to relative newcomers to the market.

In today's market environment, where certain shares regularly outperform our long-term goal of 15.5% annual appreciation on a single trading day and long-term investing is measured in months (or even weeks) and not years, Drip investing can seem downright old-fashioned. Let's face it -- given the over 80% return of the Nasdaq composite over the past 12 months, why should people wait 17 years for a big payoff from their stocks?

Here at the Drip Port, we make no pretenses that our style of investing will put smiles on everyone's faces. However, we are very confident that our low-cost, easy-does-it strategy will work for us, based on the types of Fools we are. We are in no rush for results. We have a 17-year time horizon. We are willing to spend about five minutes, on average, managing our investments every month, basically enough time to decide which company will receive our $100 in monthly investment money.

Given those character traits, expecting an 80% return anywhere along the line is not rational. Heck, we don't even care about beating the market. All we care about is earning a 15.5% average annual compounded return on our money after 17 years, plain and simple.

If we are smart about the companies we choose as investments, we should end up in good shape. We don't have any particularly illuminating insights into business or the subject of investing. Rather, our advantage as investors comes from other areas, chief among them time, patience, discipline, and the power of compounding.

With that philosophy in mind, it should come as no surprise that we like to invest in large, industry-leading companies that have some staying power. We also put a great deal of emphasis on quaint ideas such as valuation and dividends, which today seem to be the financial equivalents of bloomers and pocket watches. The first concept steers us clear of fads and stocks with too much price-related risk, while the second provides a low-cost form of long-term portfolio performance insurance.

To understand our preference for dividends, let's look at our healthcare holding Johnson & Johnson (NYSE: JNJ). In 1999, J&J paid an annual dividend of $1.09 per share, which based on last night's closing price of $92 9/16 per share works out to a yield of 1.18%. Further, the company has increased its dividend payment by an average of 15% for the past 23 years. (J&J's record of annual dividend increases actually goes back much farther to 36 years, at last count.) What does this mean for long-term investors like us?

Let's find out using a simple example. For our purposes, let's assume a few things: 1) J&J continues to increase its dividend 15% annually for our 17-year holding period, 2) the company's share price stays fixed at $92 9/16 per share throughout the holding period, and 3) no additional money is added to our existing position. In this way, we can isolate the income effects of the dividends alone and what they contribute to our overall long-term expected performance.

After 17 years of annual 15% increases, J&J's dividend will be $11.73 per share. Holding the share price steady, that works out to a dividend yield of 12.67% -- a better yield than most junk bonds, but with much less risk.

Further, the total dividend payments that we can expect to receive from each share of J&J under our scenario are $81.56 over 17 years. Since we currently hold 11.292 shares in the portfolio already, that would work out to $920.97 in total dividend payments coming our way. Taxed at an assumed 30% rate, that's $644.67 in cash, which we could use to buy 6.964 additional J&J shares at our fixed share price.

Here's how the value of our J&J holdings would change over time:

Year 1

11.292 shares @ $92 9/16 per share = $1045.21

Year 17

18.256 shares @ $92 9/16 per share = $1689.82

Total after-tax annual compounded return = 2.87%

THAT STINKS, right? By itself, yes, but remember our example includes zippo in terms of share price appreciation over the 17-year period. With a 2.87% annual return from the dividends, our J&J shares do not need to advance at a 15.5% compounded rate to hit our goal. Instead, they only have to rise at a 12.63% annual rate. That's still a faster clip than the S&P 500 grew during the last century (isn't that so weird to say?) but it is much more manageable than 15.5% every year.

By the way, the longer the time period is extended, the more dramatic the return from the dividends. For example, lengthening our scenario by another 17 years -- to 34 years of 15% annual dividend increases -- will produce another $877.80 per share in dividends pretax. In the 34th year, the dividend would jump to a whopping $126.23 per share for a Russian-bonds-in-crisis yield of 136%. After-tax, the annual compounded return from the dividends alone would work out to 6.4%, meaning we could get away with even less share price appreciation and still meet our long-term return goals.

It is for these reasons, in conjunction with many others, that we think Dripping is a great idea for young investors with very L-O-N-G time horizons. Sure, it is a hard strategy to get excited about when the market is handing out unusually high, short-term returns like lollipops for all types of stocks, as is the case right now. But then again, low risk in investing comes at a price, and that price is typically measured in years.

Drip Portfolio

1/7/00 Closing Numbers
Ticker Company Dly Pr Chg Price
CPBCAMPBELL SOUP11/16$37.00
INTCINTEL CORP1/4$82.00
JNJJOHNSON & JOHNSON15/16$96.50
MELMELLON FINANCIAL CORP1/4$32.13

  Day Week Month Year
To Date
Since
7/28/97
Annualized
Drip 3.22% -.93% -.93% -.93% 28.71% 10.86%
S&P 500 2.71% -1.89% -1.89% -1.89% 53.55% 19.15%
S&P 500(DA) 2.71% -1.89% -1.89% -1.89% 56.17% 19.98%
S&P 500(DCA) n/a n/a n/a n/a 29.14% 11.01%
NASDAQ 4.17% -4.59% -4.59% -4.59% 147.37% 44.78%

Trade Date # Shares Ticker Cost/Share Price LT % Val Chg
9/8/9722.3909INTC44.603$82.0083.84%
11/14/9711.292JNJ80.007$96.5020.61%
11/5/9828.3741MEL34.416$32.13-6.66%
4/13/988.174CPB54.586$37.00-32.22%

Trade Date # Shares Ticker Cost Value LT $ Val Ch
9/8/9722.3909INTC$998.70$1,836.05$837.35
11/14/9711.292JNJ$903.44$1,089.68$186.24
11/5/9828.3741MEL$976.51$911.52($65.00)
4/13/988.174CPB$446.18$302.44($143.74)
  Cash: $24.32  
  Total: $4,164.01  


Key
• S&P 500 (DA) = dividend adjusted. Dividends have been added to the total return of the index.

Note
Drip Port launched with $500 on July 28, 1997, adds $100 to invest every month, and the goal is to own $150,000 in stock by August of the year 2017. Due to the slow nature of dollar-cost-averaging and our relatively significant starting costs, we do not expect to seriously challenge the S&P 500 for the first three to five years as we build an investment base. The long-term advantages of dollar-cost-averaging still overcome the short-term disadvantages, however. Final note: our investment in Campbell Soup is frozen due to fees instituted in its investment plan. Click here for a history of all Drip Port transactions.