Thursday, March 18, 2010

Does anyone do any stock investing with drips? Dividend reinvestment plans?

I do drips on my US stocks since I have little use for converting every little U.S. denominated dividend into Cdn Dollars.

Some of the advantages are that you don't pay brokerage commissions.
Sometimes you get a slight discount on the market price.
It is a painless form of cost averaging.

If you invest in good (not exessively high) dividend yielding companies that on a regular (or even better anual) basis increase their dividends, some historical studies show that on average you make around 12-15% per year. The dividend increases provide inflation protection that no GIC will provide.

John Drehman claims that investing in dividend paying stocks at average Price Earning ratios or Price over Book Value ratios results in better long term results than in Growth or Momentum Stocks. Jeremy Siegel calculated that over the long term, dividend reinvested stocks perform better with market crashes than without. During the crashes, they paid out dividends (although sometimes temporarily reduced) and allow you, unemotionally to buy lots of shares at undervalued market prices. You buy only a few when the market is overpriced. Jeremy went so far as to conclude that if you bought $1000 S&P500 stocks and their survivor stocks, at the market peak of 1929 and reinvested the dividends every year, including during the Great Depression then by 1954, your investment value would be $4440. If there had been no Great Depression and the market had moved at a steady pace to the same 1954 market level, your investment value would have been $2720.

Here is an another example of how important dividends are: If you bought in February 1987 a share of the Royal Bank at 5 dollars, today coming out of the recent Great Recession, it is valued at just under $60.00. So that is a nearly 12 fold increase in value. Dividend yields of the RY hover typically in the 3 to 5%. So in 1987, RY paid $0.25 per share per year. Today that dividend is: $2.00.

Assuming a gradual increase without crashes (the less favorable scenario according to Siegel), with reinvested dividends your investment value would be: $142.6 where $60 is the appreciation of your original $5 share and a whopping $82 comes from the reinvested dividends.

If, instead you had invested $5 in a growth stock like Nortel in 1987 today's investment would be zero. Or if you had invested that amount in high flying Bombardier you would today have: $30.00

Does this make you a believer in investing in dividend paying stocks and reinvesting the dividends? It is one of the strategies I have followed. But you know, I diversify and I invest also a lot in oil and gas - only large companies though and preferably ones that pay a bit of dividend. I did invest in juniors through a flow through share fund. I fell flat on my face.

Rather than investing and reinvesting in dividend paying stocks, you can also invest in exchange traded funds (ETFs) that mimmick the TSE300 or TSE60 and reinvest dividends that way. This is investing for dummies and you probably do better OVER THE LONG TERM than investing in a mutual fund.

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