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DRIPs 101: The Basics

Robert Gibb

Since beginning this column I’ve received many wonderful e-mails and phone calls from MoneySaver readers across North America and as far away as Norway. Often these contacts are requests for information that can be used to help educate members in ShareClub meetings. Therefore, I’m going to devote the next few columns to DRIP basics.

DRIP - Definitions

I’ve come across several:

Strictly speaking Dividend Reinvestment Plans (DRIPs) are company sponsored plans that allow shareholders of record to reinvest dividends in further company shares usually at little or no cost. The very best DRIPs offer a Stock Purchase Plan (SPP). SPPs allow the shareholder to purchase further shares directly from the company or through its transfer agent (TA) again for little or no commission and in low dollar amounts. SPPs are called OCPs (Optional Cash Plans) in the United States. DRIPs avoid the use of a third party broker when making equity purchases.

While technically correct, I somehow feel the definition above doesn’t reflect how the DRIPping community defines the situation. To most individuals DRIPping is simply the ability to buy stocks in small dollar amounts and avoid commissions in doing so.

How DRIPs Work

Before someone buys shares in companies through a broker they are required to sign a power of attorney. The power of attorney allows the broker to act as owner on a person’s behalf. Companies often bestow benefits, such as free dividend reinvestment, to an owner. When an individual’s shares are held in an account, the company recognizes the broker as the owner. Benefits of ownership go through the broker.

Brokers hold a person’s shares in street name. If a company-stated minimum number of shares are removed from street name, the individual, not the broker, is recognized as owner. The owner can then enroll in the company DRIP. The minimum number of shares required to enroll in most instances is one (1). It is important to make sure of the minimum before attempting to enroll in a DRIP. As an example, Pepsi requires five (5) shares to start a DRIP. Once enrolled, any benefits are now directed to the individual, not the broker.

Benefits in a pure DRIP, such as TD Waterhouse (TSX:TD), allow any dividends payable to be reinvested in further shares at no cost to the shareholder. If a company, such as Bank of Montreal (TSX:BMO), offers a DRIP with SPP the individual can also, on an optional basis, purchase further shares as well in dollar amounts directly from the company (up to $40,000 annually from BMO). Thus, broker fees are eliminated.

It is important to note here that the vast majority of active DRIPpers actually use the term DRIP when they mean DRIP + SPP. This sometimes causes confusion, especially when someone asks their broker about DRIPs. Brokers offer Synthetic DRIPs. Synthetic DRIPs mimic pure DRIPs but only offer SPP features if the individual pays the further broker commissions! The six different types of DRIPs will be covered in the next column.

Advantages

To the company, an advantage can be reduced costs. Disney and McDonald’s are classic examples. It is estimated both companies have over a million shareholders with ten or less shares. Offering a DRIP reduces the cost of mailing out all those dividend cheques. It is also suggested that a DRIP helps moderate share price fluctuation as it creates a steady stream of purchasers. Share owners are also likely to show greater product loyalty.

To the individual there is an ability to buy more shares in small dollar amounts while income averaging. Often, too, companies provide other benefits. Did you receive your Dofasco calendar this year or your reduced price offer for online games from BCE? Wrigley’s sends shareowners gum. I received a reduced price offer from Compaq on a new line of computers (only available in the USA though).

Disadvantages

You’re going to get paper. Each company will send quarterly statements. Paper can pile up. Then again, I look forward to opening my mailbox everyday. I suppose it’s a matter of perspective. Another negative, often suggested, is that you can’t market time. I always find that a curious statement against DRIPs as these same writers in other columns say it’s impossible to market time anyway. Personally, I disagree. Within a certain definition I use my DRIPs to market time as I buy my laggards.

Overlooked Stocks

I recently read The Streetsmart Guide to Overlooked Stocks (McGraw-Hill, ISBN: 0-07-140678-6, $47.95) by George Fisher. Mr. Fisher, of course, began appearing in Canadian MoneySaver on a regular basis recently. While not strictly a DRIP book, I think it has great relevance for Canadians (and not just because I’m featured on a couple of pages). I tend to view Canadian DRIPs more as savings plans. Canadians have only about twenty-five mature DRIPs to choose among. On the other hand, there are now an estimated 1700 U.S.-based DRIPs. Many of these companies are small and mid-cap and present greater potential growth prospects. Mr. Fisher provides an excellent method for evaluating smaller companies. It is easy to pick a Johnson and Johnson, a Pepsi or an Intel. For Canadians mining for buried treasure in U.S. DRIPs, this book is a must. In fact, this book was a major source of inspiration for three of my U.S. recommendations in my January column. (No, I do not get a royalty. It’s just a good book.)

Current Events

Missed in all the hullabaloo about MicroSoft paying a dividend was the fact that at the same time they also introduced a Direct Stock Purchase Plan (DSP).

Jim Otar now has a web site featuring his DRIP recommendations at http://retirementoptimizer.com/.

Robert Gibb, 106-1217 Pandora Avenue, Victoria, BC, V8V 3R3 (250) 383-7075 [email protected]. He gives seminars on dividend reinvestment plans. Robert is a frequent contributor to Internet DRIP boards under the nickname OperaBob.

© Canadian MoneySaver, PO Box 370, Bath, ON K0H 1G0 613-352-7448 - Published March 2003