DRIPS are a good tool for the passive retail investor to reinvest his income in a market neutral, disciplined way.
“If you take those dividends and run, you can only spend them once. Reinvest them, and they’ll work for you forever” is how someone praised DRIPs recently.
Dividends are reinvested quarterly, free of commission – if your broker supports DRIPS . You can take advantage of compounding and dollar cost averaging at the same time.
They enable the retail income investor to be both passive and disciplined. Any tool that enables the individual investor to be structured and disciplined in his approach can only be viewed as positive.
I am neither passive nor retail. I actively manage my dividend income. Here’s how:
Firstly, I view dividend income in the same way as I do new cash coming into the portfolio. It’s all capital to be allocated – eventually. I should add that I trade infrequently, so brokerage commissions using this approach v DRIPS are not a significant factor.
Secondly, on the list of income stocks that I monitor there are always some I would like to acquire when they are value priced. Periodically, the market overreacts to some short term event affecting one of the companies on this list and reprices one of these stocks attractively. Some examples:
BP(BP/) after the Gulf Oil spill in 2010 > – 50% of its value in 10 weeks
Tesco(TSCO.L)2012 after a profit warning -18% in 2 days.
Proctor and Gamble(PG) Q1 earnings shortfall back in 2000 > – 50% of its value
McDonalds (MCD) 2002-2003 > – 50% of its value
As these examples show, periodically, quality names become available at attractive prices. To take advantage of these opportunities you not only have to be disciplined and patient, you also have to have the cash. There is nothing worse than seeing an opportunity and not being able to take advantage of it. Sometimes the whole market is on sale as it was in 2008/09. You also have to able to pull the trigger on these opportunities when they arise, but that’s the subject of another article.
To conclude, I think the biggest drawback with the passive DRIP approach is that often you ‘buy’ current yield when it is not value priced. DRIPing into McDonalds at today’s price of 100, with a P/E of 20 and current yield of 2.79% is not good value. Suddenly, last Thurs (12/01) Tesco’s the UK supermarket giant issued a profits warning. A day later TSCO was 18% cheaper, value priced with a P/E of 8.77 and the highest yield (4.65)in 20 years. Almost 200 basis points higher than MCD.
Basically, the approach I outlined not only allows me to consistently apply my buy criteria across all cash flows in the portfolio, it also gives me extra cash to do it.