In the investing world when you receive a dividend you have a few options for what to do with that money.
Unless you need the cash soon, then a very efficient thing to do is to re-invest it in more shares. But that costs money in trading fees and time as you have to setup the purchase.
In comes the concept of a DRIP. It’s a Dividend Reinvestment Plan where you as an investor can have your dividend payouts automatically be re-invested towards the purchase of additional stocks within that company.
Getting started with DRIPs is (unfortunately) complicated, so let’s glaze over that for a moment and instead focus on what actually happens when you drip.
Let’s say you own 300 shares of Pizza Pizza (PZA.TO). Pizza Pizza pays out a dividend of $0.07 a share, earning you $21.
300 # Shares x $ 0.07 Dividend per share ------- $21.00 Total payout
Instead of collecting that dividend as cash, your DRIP will be used to buy more shares. At a current price of $8.67, you could buy 2.42 additional shares of Pizza Pizza.
$21 # Total payout / $8.67 # Current Share Price ------- 2.42 Number of new shares purchased
Most companies that do DRIP will allow fractional shares, which means you can fully re-invest all of your payout. So we now own 302.42 shares of Pizza PIzza.
Another month goes by (our Pizza Pizza example pays out dividends monthly), and another dividends is received.
302.42 # Shares x $ 0.07 Dividend per share ------- $21.17 Total payout / $8.67 Let's assume same price ------- 2.44 New number of shares purchased + 302.42 Original # Shares ------- 304.86 New total number of shares
So in two months we have picked up almost 5 new shares, which will each earn $0.07 every month which can be used to buy more shares, which will produce more dividends, which will buy more shares.
If we assume the price of Pizza Pizza stays flat and does not change, then by doing absolutely nothing, after a year we would have around 30 new shares.
|Months||Starting # Shares||Share Price||Dividend Amount||Dividend Payout||# DRIP Shares||Ending # Shares|
After 10 years (120 months), you have now over 780 shares compared to your original 300. And those extra shares will earn you more dividends which can buy you more shares.
|Years||Starting # Shares||Share Price||Dividend Amount||Dividend Payout||# DRIP Shares||Ending # Shares|
After 20 years you have over 2000 shares, and after 30 years over 5000! What used to earn you $21/month is now earning you $380/month, and again the stock was flat and there were no dividend increases over that time; the only thing worse with a dividend yielding stock would be if it went bankrupt.
Without a DRIP, you maintain your 300 shares, and you continue to receive $21/month. With a DRIP you are slowing adding more shares to your stockpile which will earn more dividends to be able to buy more shares. After 30 years, if you now wanted to spend your dividends then you have expontentially more available (almost $400/month).
Alas, the major stumbling block to getting started with authentic DRIPs is that it is extremely painful to register for a DRIP, and not all companies (sadly, our example Pizza Pizza does not) offer a DRIP.
All is not lost, in an upcoming article we will talk about synethic DRIPs. They are not as good as authentic DRIPs, but they are available by many (all?) major brokerage firms (like Questrade) and to ALL dividending yielding stocks.