Ensuring Dividend Survivability

The continuance of a dividend is never assured, but there are a number of things the investor can examine that will offer confidence of the dividend’s survivability, or act as a red flag. We examine these metrics, look at some example companies, and link to sources where this information can be found for any company.

My wife saw an advertisement on television for a peeler.  It showed someone peeling apples, pears, carrots, and on and on.  As this had been one of her frustrations in the kitchen she ordered it, saying that it would change her life.

When it arrived, to be gentle, it did not exactly work as well as advertised.  I tried using it myself with as little success as she had had.  Today it is in the basement, in a box of things we would like to give away, but wouldn’t want to burden anyone with.

Purchasing on a promise is that we do.  We buy things because they promise to help us in some way.  Sometimes they do, sometimes they do not.  When we purchase something with the hope that it will help us and it does not, we know that if we had had that knowledge beforehand we would not have made the purchase in the first place.

Dividend stocks are in the same category.  When researching a company we look at the expectation of future growth, we look at the expectation of stability, and we look at the expectation of the dividend.  As we look at financial statements there are indicators with each of these aspects, and as the first two are outside of the scope of this writing, I will focus on the dividend.

This is essential because if there are red flags implying a possible cut or removal of the dividend, then the only path forward is to value the company without this key aspect.  As dividend stocks rely on this quarterly payout to attract and hold investors, valuation without the expected dividend will almost certainly mark the company as a sale.

There are a number of metrics that we can examine that will give us an indication as to what we should be looking for.  We will also look at a few companies to see how they are evaluated through these metrics.

Dividend Payout Ratio

The Dividend Payout Ratio is the most commonly used metric.  It is expressed as a percentage, and is found by dividing the annualized dividend per share by the earnings per share.  This shows the percentage of the company’s earnings that are shared with the investor through dividends.  (The opposite of this would be the retention ratio, which is the percentage of earnings that are not given to shareholders, but are retained by the company.)

The two obvious endpoints come with payout ratios less than 0% and higher than 100%.  The former can happen if estimates of earnings per share for the next year are negative, meaning that the company is losing money.  If the company is losing money then it has no business going further into debt by offering a dividend.

When payout ratios exceed 100% the company is making money, but more dividends than earnings are going to the shareholders.  This is not a sustainable event.  It is possible that a company with a long history of dividends may not want to cut or suspend the payments, and if a one-time event (lawsuit, catastrophic event, etc.) is the source of payout ratio then they may allow this to happen, but it is not a positive trend.

Payout ratios over 50% are considered to be high.  From the investor’s point of view a ratio this large might be a positive event.  But for the long term investor it means that the retained earnings may not be enough for the company to sufficiently invest in future growth, which could then stunt the ability of the company to increase dividends in the future.

A payout ratio over 75% trends toward the more severe end.  A lack of future growth not only puts dividend increases in the future into jeopardy, but the company’s stock can drop as a result, subjecting the investor to the worst of both worlds.

The Dividend Payout Ratio is easy to find.  NASDAQ.com offers the information on their website – here are links to three companies in my dividend portfolio where I have owned DRiPs an average of 20 years, MMMAflac and Johnson & Johnson.  As can be seen from these three companies, the payout ratio is in the area of comfort.

Dividend Payout Ratio

Johnson & Johnson22.3%

Cash Dividend Payout Ratio

The Cash Dividend Payout Ratio is similar to the Dividend Payout Ratio, but provides a better analysis of the sustainability of the company’s dividend.  Instead of comparing dividends to earnings, the dividends are compared to cash flow, so the formula looks like this:

Cash Dividend Payout = dividends / (cash flow – capital expenditures – preferred dividends)

Preferred dividends are given to shareholders of preferred stock, which basically means that they have priority over holders of common stock.  If a company is unable to pay all of their dividends then those with preferred shares are first in line to get theirs.

At first glance this may seem to be a number that would pretty much be the same as the Dividend Payout Ratio, and in a perfect world that would be the case.  The difference is that earnings can be manipulated considerably easier than cash flow.

Earnings manipulation is not necessarily intentional fraud, but can be performed through legal accounting tricks that make the company appear to be more profitable than would otherwise be the case.  Obviously, the more earnings a company shows, the more positively it is viewed.  Examples of this manipulation could be capitalization practices, modifying the timing of operating activities, and merger-related expenses.

Cash flow is the movement of money in and out of the business.  While it is possible to manipulate cash flow, it is much more difficult, so using cash flow instead of earnings in the equation can offer a more reliable number.

SeekingAlpha.com offers this information for MMMAflac and Johnson & Johnson and again looking at the companies listed above we can record their numbers. 

Cash Dividend Payout Ratio

Johnson & Johnson49.9%

For these three excellent companies we see a wide range with the cash dividend payout ratios.  I generally look to the guidance noted above as far as what might be considered to be high and low. 

MMM’s Cash Dividend Payout Ratio appears to be on the high side, but no number should be seen in isolation.  Information of this sort should not be used by itself to make a decision but should be seen in conjunction with additional information to determine its relevance.  In this case MMM’s number is something to note and keep in mind while investigating other information.

MMM has increased their dividend every year since 1959, weathering seven recessions, so it would be extraordinary if they were to decide to end this streak.  As this is a company that has historically placed importance on maintaining their dividend, the expectation is that they will continue to do so.  We need to make sure that they actually will be able to do this.

Financial Debt Ratios

Financial debt is simply money owed by the company that is to be paid back at a future date.  This could include short term debt (due within one year), long term debt, deferred revenues, pension liabilities, and many other items. 

Debt is not necessarily a bad thing, after all one might go into debt to purchase a car, which in turn could make it possible for the individual to travel further for a higher paying job.  The same is true with companies – properly structured debt can be used to the company’s advantage (for instance, paying 4% interest on something that offers 6% in return).

Certainly, too much debt can cause major problems.  The required outflows of money limit the amount that can be used for investing back into the company, as well as dividends.  Understanding the ratio of debt to certain other issues gives us an insight as to how the debt is affecting the company.

Debt to EBITDA

EBITA stands for Earnings Before Interest, Taxes, and Amortization.  While EBITA is not recognized in the generally accepted accounting principles, it is a commonly used number that generally references the company’s operating profitability.  Comparing the debt to profitability gives us an indication as to how much the debt is dragging on a company’s earnings.

Gurufocus.com notes that according to Joel Tillinghast (Big Money Thinks Small: Biases, Blind Spots, and Smarter Investing) a ratio of Debt-to-EBITDA above 4 is a concern unless tangible assets cover the debt.  A ratio under 1 would be considered to be very positive.

Thanks to this Gurufocus, the Debt to EBITA ratio is conveniently located for MMMAflac and Johnson & Johnson.

Debt to EBITDA Ratio

Johnson & Johnson1.24

While MMM has the highest in this small group, the Gurufocus’s MMM page also indicates that while MMM’s debt to EBITA ratio is at a 10 year high, this number is ranked lower than 55% of the 1,843 companies in the Industrial Products category, so that should be taken into consideration.

Interestingly, Aflac and Johnson & Johnson both rank higher than 51% and 59% of the companies in the Insurance and Drug Manufacturers industries.

Debt to Assets

A comparison of debt to assets offers an indication as to how much the company’s assets are leveraged after accounting for their securities.  A ratio of 0.5 or larger might be a cause for concern, but the industry in which the company fits under has much to do with this number.  After all, a company that makes products to sell (like MMM) would have many assets, whereas an insurance company (like Aflac) would have considerably fewer.

While I do not consider this ratio to be as significant in terms of a dividend’s stability as the above numbers, it is valuable in that offers an insight to the degree which the company is using debt to finance its assets.  In other words, a number of 0.3 means that 30% of its assets are financed through debt while 70% is owned by the shareholders.

Again, Gurufocus offers this information for MMMAflac and Johnson & Johnson.

Debt to Asset Ratio

Johnson & Johnson0.19

Not only is MMM’s number high, but it is also high when compared to other companies in the same space.  As stated above, these numbers should not be viewed by themselves, but in coordination with other numbers.  When looked at together the company’s high Cash Dividend Payout, Debt to EBITDA, and Debt to Asset ratios together must make one take notice of their situation.

Delving further into the numbers, we see that MMM is currently saddled with $14 billion in debt, which even for a company of its size is substantial.  Chances are that this company’s dividend is safe, but the data points noted should make holders of the stock pay closer attention to the quarterly reports.  In this case I would suggest that MMM is neither a green flag nor a red flag, but more a yellow one, or caution.  I have confidence that they will do what they can to continue to increase the dividend well into the future, but need to continue to monitor the situation to make sure that events do not overcome the company’s desires.

Evaluating companies to ensure that their dividend is secure is important and necessary for owners of dividend stocks and those thinking about a purchase.  The company’s dividend is an essential part of the reason for owning the stock, and making sure that the dividend is retained will bring stability to one’s portfolio.

Qualified vs. Unqualified Dividends

There is a big difference between qualified and unqualified dividends, and that difference could determine whether or not one will pay taxes on them.

There is no getting around taxes.  It hits us each year and each year it is a double whammy – not only does money go away, but there is frustration in simply figuring out how much is to go away.  One need to somehow find ways to make an utterly dismal task palatable.

One of the few smiles possible is that of finding that one is able to take advantage of a tax break.  Tax breaks are not only for millionaires and billionaires, but can be found for the small investor.  That is the case when considering qualified and unqualified dividends, and that is why we need to understand the difference between the two types.

Qualified Dividends

The good news is that most stock dividends fall into the category of qualified dividends.  To be classified as a qualified dividend, the IRS lists three categories, each under which the dividend must fall.

  • The dividends must have been paid by a U.S. corporation or a qualified foreign corporation.

There is a list of about 75 countries with which the United States has an income tax treaty.  I find it interesting that in addition to Russia being included, so it the USSR (I thought they went away in the early 1990s).   It is almost certain that the company in which one is investing will be covered within this group.

  • The dividends are not of the type listed later under Dividends that are not qualified dividends.

This is one of those non-helpful descriptions one often gets within government documents.  Generally speaking, what they are talking about are special cases, like dividends from cooperative banks and credit unions that should be reported as interest income, dividends from tax-exempt organizations, and a handful of other issues that are not common.

  • You must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.

This is a more common situation for investors who are trading stocks more frequently than the long term investor.  One must have owned the stock for a required amount of time around the ex-dividend date.  In this case, the holding period starts 60 days before the ex-dividend date and ends the 60 days after.  Within this 121 stretch of days, one must have owned the stock for at least 61 of those days.

As an example, one purchases shares of a company on July 5, the ex-dividend date is July 12 and the shares are sold August 8.  The dividends the investor received would then not be considered qualified dividends because the shares were only owned for 34 days.  If the investor had held the shares until November 1 then they would have been owned for more than 60 days within the May 13 (60 days before the ex-dividend date) – September 10 (60 days after the ex-dividend date) timeframe, thus the dividends would be considered to be qualified.

And yes, as always appears to be the case, there are exceptions to this, but they are rather uncommon.

Unqualified Dividends

Unqualified dividends are alternatively called common dividends.  Generally speaking, these are dividends that do not fall into all of the three categories outlined above.  There are some categories like REITs, employee stock options, dividends from money market accounts, and special one-time dividends that designate them in the unqualified category, but for the most part, if one is purchasing dividend stocks for the long term then almost certainly all dividends will be considered qualified.

The information for each company and mutual fund as to the total amount of dividends for the year and the amount that is qualified is listed on lines 1a and 1b on the 1099-DIV that is received at the beginning of the year.

Tax Implications

The reason that the distinction between these two types of dividends is so important is that they are taxed differently.  Nonqualified dividends are taxed at the capital gains rate.  This means that there is no difference (tax-wise) between dividends that are considered nonqualified and regular income.

On the other hand, qualified dividends are taxed at a lower rate – if at all.  If a single filer receives $39,375 or less in qualified dividends then those dividends are tax-free.  Joint filers get to collect up to $78,750 without having to pay taxes on those dividends.

2019 Single Filer Tax Brackets

Income Tax BracketIncome Tax RateCapital Gains Rate
$0 – $9,70010%0%
$9,526 – $39,37512%0%
$39,376 – $39,47512%15%
$39,476 – $84,20022%15%
$84,201 – $160,72524%15%
$160,726 – $204,10032%15%
$204,101 – $434,55035%15%
$434,551 – $510,30035%20%

2019 Joint Filer Tax Brackets

Income Tax BracketIncome Tax RateCapital Gains Rate
$0 – $19,40010%0%
$19,401 – $78,75012%0%
$78,751 – $78,95012%15%
$78,951 – $168,40022%15%
$168,401 – $321,45024%15%
$321,451 – $408,20032%15%
$408,201 – $488,85035%15%
$488,851 – $612,35035%20%

The charts for the 2020 tax year are scheduled to allow for slightly higher income tax brackets, so the single filer will be able to receive up to $40,000 in dividends and joint filers will be able to receive up to $80,000 without having to pay taxes on the dividends.

As can be seen from the charts above, this makes for a very strong retirement strategy.  If a single filer were to have a million dollar portfolio of dividend stocks offering an average dividend yield of 3.5%, it would result in $35,000 in dividends that would not be taxed.  If the filer needed $50,000 during the year then that $15,000 of non-dividend money would be taxed at a lower rate than if the entire $50,000 came outside of dividends.  Joint files would double those amounts.

It is clear that there is a huge tax advantage to ensuring that dividends are qualified.  The stream of cash from qualified dividends is almost like taking money from a Roth IRA unscathed by taxes. When I start the chore of working on my taxes in March I will be grumbling until I get to the part where I report my dividends, knowing that that income will pass through without being touched by the taxman.

Two Ways to DRiP – Part 2

The traditional means of DRiPping is perhaps not the best, but the option should at least be understood.

Choices are good, and if I were in the process of creating a DRiP portfolio then the means I described in the previous article would probably be the direction I would take.  That said, it is good to understand one’s choices, so I will explain the original approach I took years ago.

My grandfather worked for AT&T and over the decades, being an employee, he was able to accumulate a large number of shares of the company.  Each paycheck some of his money went to the company and was invested in their stock, with the dividends reinvested.  Generally speaking, this is the traditional means of participating in a dividend reinvestment program.

For one to be able to participate in a company’s DRiP they must initially be the actual owner of that company’s stock.  This is not as straightforward as one might think.  Purchasing shares of a company through a broker does not actually mean that one owns those shares – they do not – the shares are owned by the broker for the client.  This is called owning shares in street name.

Brokers hold stock in street name for convenience.  A lot goes into the transfer of stock from one entity to another, and were the broker required to convert ownership for every trade, the overhead would be time-consuming and costly.  Of course, owning stock in street name still gives the owner all of the rights that are afforded to the true holder of the stock.

To be allowed to participate in a dividend reinvestment program one must own a certain number of shares (usually just one) in the company.  This means that while one can make a purchase through a broker, they can only be the actual owner of the stock by asking the broker to transfer the stock to them.

This involves the issuance of a stock certificate, and there will probably be a cost associated with this.  For instance, looking at the fees listed on eTrade and TD Ameritrade the cost is $500 for the service, which sounds crazy to me, but their business model is one where the customer is expected to do most of the work, so it is something that is discouraged.  There was a time when this service was free but that time has probably passed.

Fortunately, there is a less expensive and more convenient way to do this.  DirectInvesting.com can make the purchase as well as enroll the customer in the company’s dividend reinvestment program for 1/10th of this cost (less if the company one wishes to purchase happens to be their monthly special).  I have used their service in the past and can attest to the convenience of not having to obtain a physical stock certificate, mail it to the company (which should be done with the added cost of using registered mail), and fill out the application form for the program.

Although all of the holdings in my DRiP portfolio were obtained through this traditional route, I cannot think of an advantage I hold over someone who has decided to obtain their shares through a discount broker like TD Ameritrade as outlined in the previous article.  Whichever route is taken, making numerous purchases of great companies over a long period of time and having the dividends reinvested will yield great benefits.

Two Ways to DRiP – Part 1

There are a couple of good ways to be involved with dividend reinvestment programs, and one bad way.

When I originally started writing about dividend reinvestment programs for The Motley Fool twenty years ago there were three ways to get started with DRiP investing.  The first means of doing this involved companies like BuyAndHold, which ended operations in 2015 and moved their clients to a folio investing solution.

I will not be covering folio trading in this series but will explain what it is, using Folio Investing as an example.

Folio trading allows one to create their own portfolio of stocks on the broker’s platform.  Folio Investing has groups of pre-selected portfolios that one can take as is, or can be modified to accommodate one’s preference to weighting.  Building a portfolio from scratch of specific stocks is also a possibility.

This does come at a cost.  Folio Investing’s least expensive plan sets one back $15 per quarter, plus $4 per purchase.  The basic plan allows only three trades during the quarter, which is a problem for those whose strategy is to make multiple purchases each month.  This limitation can be accommodated on their platform, but doing so moves one to the more expensive plan, which rockets the cost to $29 per month (or $290 per year).

As one who seeks to minimize costs (which is one of the real powers with dividend reinvestment plans), this just does not work for me.

The first way to DRiP that does make sense is to work through a broker, not something that would have been feasible years ago.  This does not fit into the traditional mold of dividend reinvestment programs but achieves its goal in the same manner.  For this example I will look at TD Ameritrade.

The TD Ameritrade website indicates that they offer everything the DRiPper seeks to accomplish.  Their platform advertises fee-free purchases of stock, so multiple purchases of companies could be done each month.  The company also offers a dividend reinvestment program without cost, so that barrier is reached.  And finally, partial shares can be owned.

There may be limitations on these offerings that do not work.  For instance, when making a purchase one needs to specify the number of shares as opposed to the purchase amount.  This means that you cannot purchase fractional shares.  If you wish to invest $100 and the share price is $51 then the $49 will need to wait for another day.  That said, for the advantages TD Ameritrade offers, this is probably going to be an acceptable limitation.

At the time of this writing (10 Dec 2019) there could be a small catch.  TD Ameritrade is going to be acquired by Charles Schwab.  Although I could not find information anywhere on Charles Schwab’s website, I spoke with a representative who told me that they do have an option to reinvest dividends and hold fractional shares, so this may not be an issue.

I have had experience with this in the past.  I originally purchased stocks through a company (long forgotten) that was acquired by Zecco, which was then acquired by Ally.  The reasons for selecting a company to do business with may not be transferred to the new company, so one simply needs to be aware of the situation and be ready to reevaluate their decision.

The second part of this article will deal with the more traditional means of participating in dividend reinvestment programs.

The Dividend Yield and Stock Price Connection

Buying for the dividend, in the long term, is also buying for the stock price.

Fads dominate financial magazines.  A quick survey of current editions will often show recommendations of hot stocks and successful mutual funds to purchase right now.  Of course, this year’s successful mutual fund manager may not have this success last into the next year.

The magazine’s stress is on immediacy, which makes complete sense for them.  After all, they need to sell the magazine and next month they will again need to do the same.  Long term purchases are boring and by definition do not need to be changed every month, and that does not sell magazines.

The extreme fad would be day trading.  This has nothing to do with investing and is very stressful.  With immediacy paramount, stocks are purchased and held for mere days or even minutes.  Even if one is able to turn a profit (unlikely, as a study of day traders in Taiwan showed that 80% lose money), the amount of work in simply reporting the transactions to the IRS must be very time-consuming.

The investor’s chief problem – and even his worst enemy – is likely to be himself. – Benjamin Graham

For the long term investor the opposite exists.  Whereas day traders only consider factors for the very short term, dividends are important to the long term investor.  One might think that the stock’s value is the only important issue at hand, but ignoring the importance of the dividend is a real mistake.

As an example, $10,000 invested in the S&P 500 in December 1960 would have yielded a value of about $430,000 – not a bad return on investment.  However, the total return including reinvested dividends would have been almost $2,500,000, more than five times greater.

This shows that not only is it worthwhile to reinvest dividends, but hints that there may be a linkage between price and dividend growth, and indeed this is the case.

The dividend can act as the proverbial canary in a coal mine as far as understanding the health of the company is concerned.  After all, the dividend is real money.  Regardless any accounting tricks that can be employed to obfuscate or deflect accounting numbers in the quarterly report, hard cold cash cannot be denied.

A continually rising dividend rate is a reflection of the fact that the company can at least pay that money to their shareholders.  Companies can only increase dividends when they know that future cash payments will be sustainable.  Companies that cut or suspend their dividend are offering a tell that the future of the company may not be as rosy as they let on to be.

The linkage between a growing dividend and rising stock price not only makes sense, but research bears this out, showing a correlation of close to 90% over 25 year cycles.  So as the dividend grows, the price of the stock is more than likely to move in the same direction.

It is amazing that this is a fact that tends to get lost.  Looking for the next stock tip and hoping to find a clue that will allow one to buy low is a common goal for investors.  However, for those looking to advance over a long period of time, it could be that finding the safety of a dividend is the best long term bet.

This underscores the significance of the Dividend Champions List as a great starting point for finding a company in which to invest.

The Best Of All Worlds

Finding fee-free DRiPs and companies with a long history of increasing their dividend is a great place to start when researching additions to a DRiP portfolio.

Dividend Reinvestment Programs (DRiPs) offer numerous advantages to the investor who is seeking to build wealth over a long period of time with a minimum amount of risk.  This is done by selecting great companies and then making regular purchases.  While others stress about the ups and downs of the market, the DRiPper understands that when the market drops those regular purchases will obtain more shares.

As noted in the last article, when fees impinge upon those purchases it can put one in a position where it may not make sense to invest.  The good news is that there are hundreds of companies that offer fee-free purchases.  These include AFLAC, Johnson & Johnson, MMM, Aqua America and Exxon, which are the companies in my DRiP portfolio.

It could take a lot of research to figure out which companies offer fee-free DRiPs but DirectInvesting.com maintains such a list.  DirectInvesting.com is a company I have used over the years to purchase that first share and start my DRiP.  I have also taken the route of finding a less expensive means of doing this but there is value to saving time and enjoying convenience, so it’s up to you to decide which route to take.

One of the knocks about purchasing dividend stocks is that the dividend may get cut or even eliminated.  Without question, this is something that should be taken into account.  If one purchases a company because the dividend offers risk mitigation and that safety net goes away, then the reason for holding the stock may also go away.  This is not good for a long term strategy where risk is a consideration.

Many years ago I met Dave Fish, who was one of the initial moderators at DRiPInvesting.org when I created the website in 2002.  He maintained a list of what he called Dividend Champions (as well as Contenders and Challengers) and I started posting that list every month because I felt that it was so important.

Dividend Champions are companies that have increased their dividend every year over at least the past 25 years.  Of course nothing is guaranteed going into the future, but when I think about a company that continued to increase its dividend every year during the fall of the internet stocks at the beginning of the century, as well as through the financial crisis that began in 2008, I know that that is a company committed to their dividend.

Included in the list of Dividend Champions are Contenders (companies that have increased their dividend every year for 10-24 years) and Challengers (companies that have increased their dividend every year for 5-9 years).

When Dave Fish passed away the list was taken over by Justin Law, who updates it on a monthly basis and uploads it to the Information, Tools, And Forms page at DRiPInvesting.org.

Combining the two lists to find the intersection of companies with fee-free DRiPs that have increased their dividend for at least 25 years is an essential starting point for anyone wishing to find a company that might offer stable dividends going into the far future.

Dividend Champions With Fee-Free DRiPs (November 2019)

3M Company
AFLAC Incorporated
Albemarle Corp.
American States Water
Aqua America Inc.
Arrow Financial Corp.
Artesian Resources Corp. A
Black Hills Corp.
Brady Corp.
California Water Service Group
Carlisle Companies Inc.
Chubb Limited
Cincinnati Financial Corp.
Community Bank System, Inc.
Donaldson Company Inc.
Ecolab Inc.
Emerson Electric Co.
Exxon Mobil Corp.
F&M Bank Corp.
Federal Realty Investment Trust
Hormel Foods Corp.
Illinois Tool Works Inc.
Johnson & Johnson
Lancaster Colony Corp.
MDU Resources Group Inc.
Middlesex Water Company
National Fuel Gas Co.
Nucor Corp.
Parker-Hannifin Corporation
Realty Income Corp.
RLI Corp.
S&P Global Inc.
Sherwin-Williams Co.
Telephone & Data Systems Inc.
Tompkins Financial Corp.
UGI Corp.
UMB Financial Corp.
United Bankshares, Inc.
Universal Corp.
Universal Health Realty Income Trust
West Pharmaceutical Services Inc.

What Is A DRiP?

Dividend Reinvestment Programs allow one to easily build their position in a company by automatically reinvesting dividends.

Many of us go through a phase where we understand how stocks work, we understand some of the factors that contribute to the increase or decrease of the stock’s price, and therefore feel that we can anticipate these changes and start trying to time the market.  In the late 1990s we were all geniuses and in the early 2000s we were all idiots.

I started investing in Dividend Reinvestment Programs in the early 1990s and a decade later came to realize that although I survived the fall of the Internet stocks in the early 2000s, simply finding great companies and making regular investments probably would have been the more lucrative route.

Companies that offer dividends know that it is to their advantage to retain their investors.  This is one reason they might offer a Dividend Reinvestment Program. A Dividend Reinvestment Program is one where purchases of stock can be made without going through a broker, and the dividend one receives is used to purchase the company’s stock.  For example, instead of receiving a $10 dividend check, one would have that $10 used to automatically purchase as much stock as that amount would represent.

This normally results in one owning partial shares.  For instance, MMM’s current stock price is $170.09.  Instead of receiving a $10 dividend check, one would have 0.058 shares (10 / $170.09) added to their holding.

At first glance this does not seem like much, and indeed it is not.  Looking at my purchase history of MMM I see numerous dividends being converted to partial shares in this range.  I did make somewhat regular purchases through the years but today a bit over 30% of my holdings of MMM were obtained through the reinvestment of dividends.

It should be noted that some companies are charging for this service.  At one point I had a DRiP set up with The Coca-Cola Company.  I would send a check for $50 which was used to purchase $50 of stock, and my dividends were converted to stock without charge.  I no longer own shares in the company partially because they decided to start adding fees to the DRiP.

Computershare administers KO’s DRiP and below are the charges from their website.

Initial setup $10.00
Check $3.00
Per share processing (check) $0.03
One Time Investment $3.00
Recurring $2.00
Per share processing $0.03
Dividend reinvestments 5% $2.00 max
Batch sales processing (per share) $0.12
Market order sales $25.00
Market order processing (per share) $0.12

This hardly makes it worthwhile to participate.  A $50 purchase is immediately decreased by more than 6% through fees, and reinvestments similarly have a chunk taken off the top.  This means that the values of the stock needs to rise accordingly just to get back to even.

Fortunately, there are over 200 companies that offer fee-free DRiPs, meaning that you pay to have things set up and you pay to sell shares, but purchases and reinvestment are without cost.

In the next article I will delve into what I see as the first step in selecting companies that will offer you dividends for decades to come.