Buy stock one DRIP at a time

Despite a year-end rally, the stock market cooled considerably in 2004. The Standard & Poor's 500 index gained 9 percent last year versus 26 percent in 2003. But investors who pay attention to stock dividends as well as prices have plenty of reasons to be pleased.

"We saw a nice trend in dividends starting last year," says Kenneth Janke, chairman of the National Association of Investors Corp., an organization that serves investment clubs and individual investors. Recently, for example, General Electric raised its dividend 10 percent to 22 cents per share, while PepsiCo increased its quarterly dividend from 16 cents to 23 cents.

Perhaps no one appreciates this trend more than people participating in dividend reinvestment plans, or DRIPs.

DRIPs let investors buy a few shares at a time, then put the dividends back into the stock. Those reinvested dividends purchase additional shares (or partial shares) of stock. Meanwhile, investors can regularly purchase additional shares, sometimes for as little as $10 or $15. All this can be done without paying a fee or broker's commission. As a result, as dividends increase, investors with DRIPs own more shares.

"There's a lot of room for companies to start paying dividends," says Howard Silverblatt, an equity analyst with Standard & Poor's. "Companies are making money. The beginning of next year will be a busy period for dividends." All of which is good news for DRIP owners.

DRIPs "are a very neat and convenient way for investors to participate in the market on an averaging basis," says Edward Riley, chief investment strategist at State Street Global Advisors in Boston. Averaging refers to the practice of regularly buying shares of stock or mutual funds regardless of their price at the time of purchase. This way, the investor buys more shares when the price is low and fewer shares when the price is high, resulting in a lower "average" cost.

In addition, Mr. Riley says, "some companies give a small discount to their market price, so it makes a lot of sense for investors."

Until a few years ago, not many companies offered DRIPs. But in 1995, the Securities and Exchange Commission made it easier for corporations to put direct purchase plans in place. Since then, the number of companies with DRIPs has grown to more than a thousand, including such well-known names as Aflac, Ford, Procter & Gamble, McDonald's, and Gillette.

DRIPs "tend to be used by widely held companies," says William Mostyn, Gillette's corporate secretary. The minimum an investor needs to start a reinvestment account with a given company generally ranges from $250 to $2,500, although some companies let investors start DRIPs with just one share.

DRIPs got another boost in 2003 when the federal tax on corporate dividends was cut to 15 percent, the same rate as long-term capital gains. Before that, dividends had been taxed at the individual's income-tax rate. "With the new tax rate at 15 percent, it means more of your money is working for you if you're in a dividend reinvestment plan," Mr. Janke says.

In most cases, he notes, investors who only own a few shares actually cause their company to lose money because of the costs of processing paperwork, handling additional investments, and mailing statements. Most of these same companies, however, think it's worth the trouble.

"It means we have a lot more shareholders who are interested in the company," says Mr. Mostyn of Gillette. Over time, he adds, many of those investors increase their holdings and become part of a stable base of shareholders who hold onto their shares rather than trade in and out of them every few months or years. In addition, a number of people set up reinvestment plans for their children and grandchildren, he says.

DRIPs come with a few disadvantages, but most investors can work around them. To begin with, getting the first share may be time-consuming. While some companies sell the shares themselves, most use a third party or "transfer agent" such as Bank of New York, Chase Mellon, or First Chicago Trust to save money. Investors can call the company's investor relations department or visit its website to get the address and phone number of the transfer agent.

Another caveat: Watch out for fees. Many companies have converted their DRIPs to direct purchase or direct stock plans. These allow you to skip the broker and buy your first share from the company (usually a plus). But some now charge dividend-reinvestment fees, which eat into your return.

Also, investors who sign up for a DRIP with just one company could lose money if the stock experiences a major, sustained downturn. The easiest way to manage this problem is to own several stocks in different industries, not just one. "I like to see people get some diversification by buying four or five different stocks in their dividend reinvestment plans," Janke says. "So even if you guess wrong on one stock, you're not going to guess wrong on all four or five. Also, you don't have to invest in every one of them every month."

Then there are taxes. Eventually, you may want to sell your shares. When you do, you'll need to pay capital-gains taxes on any profits. This means keeping careful records - particularly quarterly statements - of when you bought each share and how much you paid for them, and deciding which shares are most advantageous to sell. Money management software programs such as Quicken can help, as long as you remember to enter each quarterly statement.

Twenty-eight of the 30 companies that make up the Dow Jones Industrial Average offer dividend reinvestment plans. As shown below, investors can open a DRIP for as little as the price of a single share.

Company Minimum investment
3M 1 share
Alcoa 1 share
Altria Group $500
American Express $1,000
Boeing 50 shares
Caterpillar $500
Coca-Cola 1 share
E.I. du Pont de Nemours 1 share
Exxon Mobil $250
General Electric $250
General Motors 1 share
Hewlett-Packard 10 shares
Home Depot $250
Honeywell 1 share
Intel 1 share
IBM $500
Johnson & Johnson 1 share
JPMorgan Chase $250
McDonald's $500
Merck $350
Microsoft $1000
Pfizer $500
Procter & Gamble $250
SBC Communications $500
United Technologies 10 shares
Verizon Communications $1,000
Wal-Mart $250
Walt Disney $1,000

Source: NetstockDirect.com