As discussed in my previous blog, Dividend Re-Investment is one of most effective ways to generate consistent incomes over time. Does that mean you need to simply look for those companies which pay out high dividend yields, e.g. at 10-20%? Wrong! Generally speaking, those companies that pay a high dividend yield are usually those which are more risky ones; the high dividend yields are generally the result of a significant drop of the underlying stock price, which pushes up the yield significantly. In other words, don't blindly chase after high dividend stocks as you may be sorry to find later that they will either stop paying dividends soon or even go belly up. Of course there are exceptions such as real estate investment trust (REITs), which are required to pay out 90% of their earnings and therefore may involve high but stable dividends. But for long-term DRIPs, I'd avoid REITs unless you really know them very well.
So what companies I'd consider for DRIPs? I want to only include such companies which I know are very safe, will pay me dividends for long long time, and more importantly will increase dividends year after year. The following are the key criteria for such companies:
- Is an industry leader with a huge business moat and sustainable competitive advantage
- In an industry that is timeless or will be around for long time
- Has a huge cash load on the balance sheet to guarantee the safety of dividends
- Has a rock-solid record of consistent dividend growth over years
The following companies meet such criteria and have at least over 10 years of history of annual dividend growth over 10%:
- Johnson and Johnson (JNJ): current dividend yield 3.55%
- McDonald's (MCD): current dividend yield 3.20%
- Walmart (WMT): current dividend yield 2.33%
- Microsoft (MSFT): current dividend yield 2.40%
- Medtronic (MDT): current dividend yield 2.34%
- Chevron (CVX): current dividend yield 2.78%
After you decide what companies to be included in your DRIPs, how to set up the automatic system?
(1) Accumulate the shares of these companies patiently. While these companies are very safe and relatively cheap to buy at the current price in terms of their intrinsic values, I just don't believe the current overall stock market. I think there is a very real risk of a significant correction in the near future. If this happens, it will bring down all the stocks in a short term regardless of their fundamentals. The best way to accumulate shares is to use the dollar-averaging method: buy certain number of shares every several weeks or months till you reach the desired total amount for the stock.
(2) As soon as you buy at least one share of a stock, enroll into the DRIP for that company. I don't know if all the brokerages have the same way for the DRIP enrollment. You may need to do some research first to check about your broker or even call your broker agent to clarify. For my online broker, Etrade, it is very simple: there is a link for DRIP, in which you can specify which stocks you want to be enrolled into the DRIP. After that, you are on your way to receive increasing income over time as long as you keep doing that.
One final note: it is important that you enroll into DRIPs via your broker, not by calling the stock companies. You broker will automatically buy a fraction of shares of the underlying company for the dividend amount each time you receive a dividend. For example, if you have 100 shares of Stock A that is traded at $21 per share and receive $34 dividend, you will get 1.62 shares of stock A and it is free of commission fees. So you will have 101.62 shares in your account. Next time your dividend will be based on 101.62 shares, not 100. Over time, it is a powerful compounding machine, which will generate more and more income for you without your knowing it!
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