The acronym, which I’m pretty sure stands for Dirty Rotten Iranian Porn (ed. note: how do you function in society?), is simply a way for an investor to automatically reinvest dividends back into shares of the underlying company, sometimes at a discount. By giving investors a discount when they use a DRIP plan, the company retains cash it can put to greater use.
DRIP actually stands for Dividend Reinvestment Plan, but you knew that already.
As much crap as I’ve talked about dividends over the years, you’d think I’d be staunchly against DRIPs. Actually, I’m pretty much meh about them. Automatically putting the dividends back into shares takes the guesswork out of investing. If the whole point of buying Telus or Coca-Cola shares is to hold them forever, then putting the dividends back into more shares isn’t bad. It turns the investment into something approximating a passive investment, which at least eliminates selling at a terrible time.
One thing DRIP investors seem to like is when a stock they own falls in price. The logic goes something like this. If the stock falls in price but the dividend remains the same (or goes higher, as is often the case with these kinds of stocks), the dividend buys more shares. That’s a good thing for an investor looking to build a long-term position in something, or so the logic goes.
Except I’m not so sure these people should really be hoping for that. Because crapping on people’s dreams is apparently what I do, here’s why I think DRIP investors who hope for lower prices are deluding themselves.
A real-life example
Wal-Mart is a dividend aristocrat that plenty of retail investors love. Let’s use it as an example.
(Full disclosure: my wife owns some Wal-Mart. She would also like y’all to know she’s up on this particular investment)
Back at the beginning of 2015, shares of the world’s largest retailer traded at $89 each. Say you decided it was a good investment at that point, even though shares were at an all-time high. It’s okay, I’ve made worse mistakes. I once told a teacher I thought college was “overrated”.
A year and a half later, Wal-Mart shares are down to $70 each, and that’s even after spending time below $60. That’s a loss of 20%, give or take a percent or two that I’m too lazy to figure out.
Let’s say you bought 100 Wal-Mart shares at the peak, paying $8,900 for the investment, less commissions. That investment is worth $7,000 now.
Not all is lost, however, because you’ve collected dividends as shares went down. Wal-Mart paid four $0.49 per share dividends in 2015, and has already paid two $0.50 per share dividends in 2016.
Let’s assume Wal-Mart had an average price of $65 throughout our little experiment. It probably didn’t, but the amount doesn’t really matter, as you’ll see.
DRIP investors would have picked up a total of $2.96 per share in dividends, for a total of $296. That would get them an extra 4.55 shares of the bad guys from Arkansas. If the price had stayed at $89, the same investor would have gotten 3.32 extra Wal-Mart shares from DRIPping. So far, it sure looks like DRIP investors should be rooting for lower prices. Instead of having 103.32 Wal-Mart shares, the DRIP investor has 104.55 shares. That’s good.
Except when we look at the total value of the whole investment. If Wal-Mart shares had stayed at $89, the investment is worth $9,195.48, a small gain. But since they’ve gone down, the whole investment is now worth $6,795.75, a pretty substantial loss.
The problem with hoping for a lower price is it ignores the capital you put to work in the first place. Wal-Mart pays a dividend of about $2 per share each year. Meanwhile, it lost $24 per share in market value. Even if the dividend continues to grow over the years, it’ll still take longer than a decade of dividend reinvestment to make up for the initial decline in price.
Or, to put it another way, celebrating the ability to DRIP cheaper shares is like rejoicing about still being alive after getting your legs bit off by a shark. It’s all about the little things…while missing the big thing completely.
The only way you should be happy about a stock declining right after you buy it is if you’re looking to average down. Other than that, stick to hoping a stock goes up. You won’t accrue as many dividends that way, but capital gains will more than make up for them.
Dividends are nice, I get that. But capital gains are even nicer.