The Power of Dividend Growth

08/07/2013 10:00 am EST


Charles Carlson

Editor, DRIP Investor

DRIP expert Chuck Carlson walks us through the benefits of dividend reinvestment plans, the importance of dividend growth for long-term investors, and some top blue chip stock ideas.

Steve Halpern: We are here today with Chuck Carlson, editor of the DRIP Investor. How are you doing, Chuck?

Chuck Carlson: I am fine, Steve, thank you.

Steve Halpern: You are widely considered the advisory industry's leading expert on dividend reinvestment plans. Could you explain what these plans are, and how they can play a role in an investor's long-term strategy?

Chuck Carlson: Sure. Dividend reinvestment plans, or otherwise known as DRIPS, are programs offered by approximately 1,000 companies that allow investors to buy stock directly from the companies. You buy stock in two ways in these plans.

First, as the name implies, instead of having dividend checks sent to you, the companies will retain those dividends for you and reinvest them back into company shares, so you are taking dividend payments and buying additional shares directly through the company. That is the first way to buy.

The second way is that, in virtually all of these plans, there is what is called an optional cash investment feature that allows investors to send, at their option, additional monies directly to the company to buy additional shares of stock.

The nice thing about investing in these plans is that a) it tends to be very low cost or, in many cases, no cost investing, where the company charges you very little or nothing to buy the stock through the plans and then b) most of the plans have very low minimum investment amounts, so for $25 or $50 or $100, an investor can start investing in some of the strongest companies, literally, in the world.

And the nice thing is, if you don't have enough money to buy a full share of stock, you can buy fractional shares of stock, and that fractional share of stock entitles you to a fractional part of the dividend, so you can literally buy stocks on the installment plan.

The nice thing about these plans, Steve, from building a portfolio, is that they really open doors for investors in order to get into the market and, more importantly, they allow investors to construct portfolios based on their own financial restraints.

If you only have a little bit of money, you can invest a little bit. If you have more, you can invest more.

As your investment dollars grow over time and you have more money to invest, you can adjust that, so they are incredibly flexible, thus allowing, again, virtually anyone to be able to craft an investment portfolio in good quality stocks, and I think that is the key thing.

You are not buying lousy stocks here. You have the option and the ability to buy some of the bluest blue chips in the land.

Steve Halpern: Is it difficult to sign up for a DRIP or is it something that the average investor can do?

Chuck Carlson: Well, if you have a telephone, you can sign up for these plans, and that is the beauty of it too. Virtually all of the plans have a toll-free number that you can call, and that toll-free number connects you to the company or the company's transfer agent, which is an entity, companies hire to administer these plans for the company.

Now, there is a little bit of a catch on some dividend reinvestment plans in that there are really two types of plans. There is kind of the old school dividend reinvestment plans, and again, these plans have been around since the 70s.

In the traditional dividend reinvestment plans, in order to participate in the plan, you first have to already be a shareholder of the company, so there is a little bit of a glitch that says: I can't buy directly from the company until I already have one share of stock.

Fortunately, over the last 15 years, there has been tremendous growth in the second type of plans, which are commonly called direct purchase plans, or which, I coined the phrase, no-load stocks, where you can go directly to the company, even to make your initial purchase of stock.

Today, there are about 400 US companies that allow you to do this. In addition to that, there are a similar number of foreign companies that allow US investors to make even their initial investment of stock directly from the company.

In that case, to get started, all of them have a toll-free number. You call the toll-free number, you request the enrollment form as well as a plan brochure, which will explain all of the details of the plan. You will have that sent out to you. You read it, you fill out the enrollment form, you cut your check, you send it in, and you are off and running. It is just that easy.

Steve Halpern: Now, for an investor to understand the real value of a dividend reinvestment plan, they really need to understand the power of dividend growth over the long-term, which is an area that you focus on. Could you explain how important that is for an investor?

Chuck Carlson: Yeah. A lot of times, investors kind of ignore dividend growth and focus primarily on dividend yield, and that has become even more the case in recent years, when investors had trouble making any kind of interest rate on their bank accounts, so they were going into stocks and looking specifically at dividend yield.

Really, over time, dividend growth is a very powerful force to have in a portfolio. It does a number of great things for you.

First, if you own stocks that are growing their dividends, it provides, kind of an inflation hedge, where you are getting more income flow from your investments to help offset the loss of purchasing power that comes with higher inflation. So, first off, dividend growth is a really good inflation hedge.

Second, a growing dividend stream that you are reinvesting back to buy additional shares of stock really accelerates the power of compounding that exists in an investment program, and the power of compounding, quite honestly, is what is going to make you rich, over time.

It may not feel like much in a year, or two, or three, but if you do this for 10, 15, 20 years, you are going to see that growing dividend stream is buying you more and more shares that, in turn, are receiving a dividend growing dividend stream that are buying more shares, and it becomes very cumulative, and compounding, and very powerful.

The last thing is, a rising dividend stream provides a bit of a safety valve on an investment, in the sense that it can accelerate what I call the payback in that investment.

For example, let's say you buy a stock and it has a dividend of 2% and never increases the dividend. It would take you, basically, 50 years of owning that stock for the dividends to equal your initial investment, so if you think of it in those terms, the payback is 50 years.

If you can buy that same stock and it is increasing its dividend 10% every year, that payback level drops to, I think, about 19 years, so, I mean, you dramatically improve the ability for paying back your investment via simply from the dividend flow. There are a lot of good things that come from dividend growth.

There is also, and I might add, there are also really good things that come from reinvesting dividends. It is one of those concepts that, you know, you talk to people about dividend reinvestment and they kind of roll their eyes.

They say big deal, you are going to reinvest your dividends, but one of the real powers of that is that you are going to reinvest those dividends and it is on an automatic basis, so that you are assured of reinvesting dividends during market periods when you should, but it is very difficult to buy.

For example, 2008 and 2009, the market is cratered. Intellectually, you know, boy, stocks are probably cheap, but it is very difficult to buy during those periods.

If you are reinvesting dividends, you are putting money back into the market at the exact time you should be, which generally is very profitable for you 12, 24, 36 months down the line, and that is exactly the case.

So, this notion of forced buying, especially during lousy market periods, that reinvesting dividends brings to an investment program, I think, is very underrated but very powerful.

Steve Halpern: So, in a way, that is forcing you to dollar cost average.

Chuck Carlson: Correct, and yes, that may not always work out for you in the short-run, but over time, that has proven to be a very winning strategy. By the way, I kind of speak from my own experience.

I have been doing this for over 20 years and have been reinvesting dividends and using option cash payments. I am in several of these programs and it has worked very effectively over that time.

Steve Halpern: Among your DRIP holdings that you comment on in your newsletter, you recently mentioned that both Paychex (PAYX) and Walgreen (WAG) have been loosening their dividends. Could you tell our listeners a little about those?

Chuck Carlson: Sure. As you mentioned, these are two holdings of mine, long-term holdings, that I have in DRIP programs. Paychex is a provider of payroll processing services and they recently increased their dividend. The stock provides a nice dividend yield in addition to that dividend growth.

Also, Paychex is an interesting stock, in the sense that, it is one company that can benefit from higher interest rates. Because of the type of business it runs, it tends to hold, literally, billions of dollars for its clients while that money is waiting to be released to pay payroll taxes and things like that.

Paychex earns the interest on those funds that it is holding, so if interest rates, particularly short-term interest rates, are rising, the interest they are earning on that big cash holding increases as well, so if you are looking for kind of a company that can benefit from higher interest rates, Paychex is that company.

In the case of Walgreen, everybody knows it is the drugstore chain. They have been raising their dividends at double-digit rates and I would expect that dividend growth to continue.

I think the stock is also a nice way to play Obamacare and the increased number of people that are kind of coming in to the healthcare system, that will need prescription drugs, that will use Walgreen's clinic services, and go into the stores, boosting their front-end sales.

Both of the stocks I do own, and I do like them very much, going forward.

Steve Halpern: Well, I really appreciate you taking the time. I am a big fan of your work and I hope that everyone listening really pays attention to what you are talking about.

Chuck Carlson: Thank you very much, Steve. It has been a pleasure.

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