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Investing in Stocks With DRPs: Adding Yield to Your Returns

by Wayne A. Thorp, CFA

Investing In Stocks With DRPs: Adding Yield To Your Returns Splash image

Many investors get caught up in the daily fluctuations of stock prices and forget about the other element of stock investment returns: dividend income.

Total return consists of price appreciation and dividend income, and while prices go up and down, dividends tend to be steadier.

A conservative, low-cost approach to investing in dividend-paying stocks is with dividend reinvestment plans (DRPs or DRIPs); particularly those that sell initial shares directly to the public (direct purchase plans, or DPPs/DIPPs). Direct purchase plans allow investors to bypass a broker, and also often the commissions they charge. With these plans, dividend payments immediately go to work for you with little or no transaction costs. [See page 15 for more information.]

If you are interested in dividend-paying stocks, DRP investing offers distinct benefits. However, it also presents unique challenges as well, such as tracking the purchase of DRP shares over time for tax purposes. By investing exclusively in companies with DRPs, you may end up with a portfolio overweighted in certain market segments. Focusing your investments on a limited number of sectors or industries can lead to a non-diversified portfolio with a rate of return that does not compensate you for your higher risk.

When used as part of a fully diversified investment portfolio, however, stocks with dividend reinvestment plans provide balance to more aggressive, high-growth holdings.

High-Yield Screens

AAII tracks two high-yield screens that seek companies from both the DRP and non-DRP universes with traits that include:

• An established history of stable or rising dividends;

• High dividend yields relative to their historical norms; and

• Earnings and dividend growth that outpaces industry norms.

Stock Investor Pro, AAII’s fundamental stock screening and research database, includes the high-yield screen for stocks offering DRPs. The program currently tracks over 1,100 companies offering dividend reinvestment plans and direct purchase plans.

What It Takes: High-Yield Screen Criteria

The following criteria are applied separately to those groups of companies offering dividend reinvestment plans and to those that do not offer dividend reinvestment plans:

  • The dividend for the last four quarters (trailing 12 months) is greater than or equal to the dividend for the last fiscal year;
  • The annual dividend has increased over each of the last five years;
  • The company has been paying a dividend for at least six years;
  • The annualized growth rate in dividends over the last five years is greater than the median annualized growth rate in dividends for the industry over the same time period;
  • The current dividend yield is greater than the average yield over the last five years;
  • The payout ratio (dividends per share divided by earnings per share) for the last four quarters (trailing 12 months) is less than or equal to 50%;
  • The annualized growth rate in earnings (total, non-diluted) over the last five years is greater than or equal to the median annualized growth rate in earnings (total, non-diluted) for the industry over the same time period; and
  • The 30 companies with the highest dividend yields from both the dividend-reinvestment-plan and non-dividend-reinvestment-plan universes are included in the final results.

Screen Performance

Each month at AAII.com, we present the 30 companies in the DRP and non-DRP universes passing the high-yield screen, and we track the performance of these stocks held in hypothetical portfolios.

Both high-yield screens have outperformed the S&P 500 index on a cumulative basis since the beginning of 1998. The high-yield DRP screen has generated a cumulative return of 79.5% over the period from January 1998 through April 2009, while the high-yield non-DRP screen returned 205.7% over the same period (Figure 1). Keep in mind that this performance does not include dividend payments or dividend reinvestment.

Furthermore, while dividends do offer some downside protection, they do not offer total insulation from market downturns. In 2007 and 2008, the high-yield DRP screen lost a total of 40.3% while the high-yield non-DRP screen was down 36.9%.

Sector Breakdown

Table 1 presents a sector breakdown of the 1,147 firms with dividend reinvestment plans currently tracked by Stock Investor Pro.

Sector DRPs
No. of
Firms
Non-DRPs
Percent
of Total
No. of
Firms
 
Percent
of Total
Basic Materials 86 7.5 598 7.1
Capital Goods 55 4.8 403 4.8
Conglomerates 9 0.8 21 0.2
Consumer Cyclical 50 4.4 360 4.3
Consumer Non-Cyclical 59 5.1 247 2.9
Energy 39 3.4 521 6.2
Financial 374 32.6 1,618 19.2
Healthcare 41 3.6 1,026 12.2
Services 240 20.9 1,676 19.9
Technology 79 6.9 1,714 20.3
Transporation 22 1.9 156 1.8
Utilities 93 8.1 93 1.1
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Historically, financial institutions and utilities offered dividend reinvestment plans to their shareholders because of their need for a steady source of equity capital. Therefore, it is not surprising that the financial sector makes up almost 33% of the DRP universe while utilities account for 8.1%. Other sectors in which DRP stocks tend to concentrate include services, basic materials, and consumer non-cyclical. The technology sector even accounts for 6.9% of the DRP universe—the fifth-highest concentration—as many of the dot-com “high-flyers” mature.

However, the technology sector still makes up the largest percentage of the non-DRP universe, at 20.3%, with service companies and financial firms following close behind at 19.9% and 19.2%, respectively, of non-DRP stocks. Technology and healthcare firms have significantly higher proportions within the non-DRP universe as compared with the DRP universe. These tend to be higher-growth sectors with smaller firms that pay little or no dividends. Individuals who limit their investments to companies with dividend reinvestment plans would tend to exclude these sectors from their portfolios, and they would be limiting themselves to dividend-paying companies within these sectors that tend to be larger and more mature.

Profiles of Passing Companies

Table 2 presents the characteristics of the companies passing the high-yield screen from both the DRP and non-DRP universes, as well as for all of the companies in both the DRP and non-DRP universes.

Portfolio Characteristics (Median) High-Yielders All
DRP
Stocks
All
Non-DRP
Stocks
Exchange-
DRPs Non-
DRPs
Listed
Stocks
Price-earnings ratio (X) 11.1 8.9 13.7 13.3 14.3
Price-to-book-value ratio (X) 1.4 0.9 1.3 1.1 1.2
Dividend yield 4.3 4.7 3 0 0
Price-earnings-to-est EPS growth (X) 1.9 1.4 1.7 1.2 1.4
Price-earnings-to-est EPS growth—div adj (X) 1.1 0.8 1.2 1.2 1.2
EPS 5-yr. historical growth rate (%) 12.3 10.8 2.6 4.1 3.9
EPS 3-5 yr. estimated growth rate (%) 7 8.5 9 13 12
DPS 5-yr. historical growth rate (%) 10.4 10.9 5 0 0
Market cap. ($ million) 6,568.80 858.7 1,292 27 278.4
Relative strength vs. S&P (S&P=0) (%) 10 7 -1 -13 -6
           
Monthly Observations          
Average no. of passing stocks 30 30      
Highest no. of passing stocks 31 31      
Lowest no. of passing stocks 19 27      
Monthly turnover (%) 26.5 29.8      

One method of identifying “value” stocks is to look for those with high dividend yields. In the case of this high-yield screen, a company’s current yield must exceed its average yield over the last five years. The median dividend yields for the top-yielding companies are 4.3% for the DRP companies and 4.7% for the non-DRP companies. By means of comparison, the typical exchange-listed stock does not even pay a dividend.

An additional requirement of the high-yield screen calls for companies to have average annual earnings per share growth rates for the last five years that are at least as high as their industry’s median growth rate. Compared to last year, there has been a dramatic shift between high-yield firms and the typical exchange-listed company. The high-yield companies from the DRP and non-DRP universes have median five-year earnings growth rates of 12.3% and 10.8%, respectively. However, whereas the typical exchange-listed stock had a median historical growth rate of 14.9% in last year’s article, this year the rate has plunged to only 3.9%.

The relative performance for the current passing companies over the last year has been noticeably stronger. Looking at the relative price strength versus the S&P 500 over the last 52 weeks, the high-yield stocks from both the DRP and non-DRP universes have outperformed the index by 10% and 7%, respectively. In contrast, the typical exchange-listed stock has unperformed the S&P 500 by 6% over the last year.

Passing Companies

Table 3 lists the top 10 exchange-listed stocks that passed the high-yield screen as of May 8, 2009, from both the DRP and non-DRP universes, with both sets ranked in descending order by current dividend yield. For backtesting purposes, we exclude stocks that trade over the counter.

Company (Exchange: Ticker) Dividend Annual Pay-
out
Ratio
(%)
52-Wk
Rel
Strgth
(%)
Price
Change
(1 Yr)
(%)
 
Yield Growth Rate  
Current
(%)
5-Yr
Avg
(%)
Div/
Shr
(%)
EPS
(%)
Est
EPS
(%)
 
 
Description
Exchange-Listed Firms With Dividend Reinvestment Plans              
AstraZeneca plc (ADR) (N: AZN) 8.3 3.2 22.9 27.2 -2 44.2 32 -13 pharmaceuticals
Bristol Myers Squibb (N: BMY) 6.1 4.7 2.1 10.6 7.7 47 35 -10 pharmaceuticals
United Bancshares OH (M: UBOH) 6.1 3.5 6.4 4.9 na 42 17 -22 bank holding co
Pearson PLC (ADR) (N: PSO) 5.7 3.4 7 10.8 8.4 47.7 20 -20 media & education
Dominion Resources (N: D) 5.5 3.7 4 44.7 7.2 42.5 7 -29 electric & natural gas
Veolia Environnement (ADR) (N: VE) 5.50 2.5 17 17 1.9 40.6 -35 -57 environ mgmt servs
Harleysville Savings Fin’l (M: HARL) 5.4 3.8 12 -0.2 na 50 48 -2 bank holding co
Avista Corp. (N: AVA) 5.3 2.9 7.1 8.8 4.7 48.3 17 -22 energy co
CRH PLC (ADR) (N: CRH) 5 2.2 19.6 14 -4.4 14 0 -33 building materials
Northeast Utilities System (N: NU) 5 3.2 7 12.8 7.4 49.4 16 -23 utility holding co
                   
Exchange-Listed Firms Without Dividend Reinvestment Plans              
Tsakos Energy Navigation (N: TNP) 8.4 5.2 38.8 25.7 na 33.3 -9 -40 oil transport servs
Brookfield Properties (N: BPO) 6.6 2.5 20.5 19.2 na 30.9 -37 -58 real estate
American River Bankshares (M: AMRB) 5.3 2.9 19.9 6.9 15 47.1 23 -18 bank holding co
Safety Insurance Group (M: SAFT) 4.8 2.5 36.3 18.6 15 40.8 36 -10 auto insurance
Landmark Bancorp (M: LARK) 4.7 2.8 8 1 na 38.1 14 -24 bank holding co
Overseas Shipholding Gp (N: OSG) 4.7 1.7 18.2 25.1 9 12.3 -28 -52 bulk shipping
Southern MO Bancorp (M: SMBC) 4.5 2.5 7.4 7 na 26 7 -29 bank parent co
Royal Bank of Canada (USA) (N: RY) 4.4 3.3 18.5 6 na 49.4 22 -19 financial servs
HF Financial Corp. (M: HFFC) 3.9 2.6 2.5 3.3 na 19.4 3 -32 thrift holding co
Hubbell Inc. (N: HUB.B) 3.9 2.9 0.9 15.6 10 37.6 16 -23 elec for construct
                   

Historically, we limit the number of passing companies to the 30 highest dividend yielders from each universe.

Conclusion

This high-yield screen identifies companies with strong dividend credentials. While firms with dividend reinvestment plans offer investors tangible benefits, such as low transaction costs, it is important that you focus on the merits of the investment itself, and then take advantage of the dividend reinvestment plan. Also, you need to consider companies with DRPs within the context of your entire investment portfolio. Do not invest in a company strictly based on whether it offers a dividend reinvestment plan.

Remember, too, stock screens such as this high-yield approach only represent a starting point in the investing process. They allow you to isolate companies with similar quantifiable characteristics. However, it is important to perform additional due diligence on any company that passes a stock screen such as this. The end goal is to find stocks that match your investing timeframe, tolerances and constraints.

Wayne A. Thorp, CFA is a vice president and senior financial analyst at AAII and editor of Computerized Investing. Follow him on Twitter at @WayneTAAII.


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