Building a DRIP Portfolio - Part 1

By Kevin Dunn - February 1, 2012 | Tickers: MMM, KO, JNJ, MCD, PG, SBUX | 0 Comments

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I'm a big fan of DRIPs for the small investor or investors who are just starting out or want to minimize risk through dollar cost averaging. So, how would we go about building a DRIP portfolio for someone in that situation? [Note: This is merely based on my opinion of how I would proceed if I were to build such a portfolio.]

First, we need to determine the preferred criteria. In this case, this would differ somewhat from the criteria I outlined previously in "To DRIP or Not to DRIP." Let's assume the following:

1. For the sake of simplicity, only DSPPs be used. Traditional DRIPs require a bit more work to set up, and we want this to be as easy as possible.

2. We want as much diversification as possible with as few stocks as possible.

3. Ideally, the portfolio will generate dividends every month of the year. The idea is that at some point the DRIP will be "turned off" so dividends can be collected in cash.

4. Solid companies with proven track records will be selected. Companies should have a history of increasing dividends a minimum of ten years though longer is better.

5. Since only DRIPs will be used, we won't impose limits such as requiring discounts or no-fee DRIPs though we will want to be mindful of fees and keep them to a minimum.

6. Initial outlay of money should be low, preferably $50 or less, though there may be exceptions. (We'll be dollar cost averaging into our positions with $50 per month plus reinvested dividends.)

So, the next question is, "Where do we start?"

Answer: The 30 companies of the Dow Jones, some of the biggest market movers out there. We won't limit ourselves to these companies, but we'll start here. We're looking to create a portfolio we won't lose sleep over, so small caps and volatile stocks are out. We can start with dividend aristocrats with payout ratios of less than 60%, P/E ratios of 20 or less, and yields of 2.5% or more.

That leaves us with five companies:

All good, solid companies to be sure, but 3M and JNJ have a traditional DRIP requiring you to own at least one share in your own name in order to set it up. If you don't mind the trouble of setting this up you could do worse than either of these companies, but for our purposes we'll pass for now.

Procter & Gamble is another good one, but you'll need to cough up $250 to get this one started, so we'll pass on this as well. Keep in mind, we'd like to get three DRIPs going, with the initial goal of buying $50 worth of stock per month per company for a total of $150 a month plus expenses. If you can spare more than that, you can make greater contributions or add more companies, but for now we're shooting for three. We're looking to build a small and simple portfolio for people short on time and money.

So, we're left with KO and MCD. I like both companies and own shares of each. Both have strong brands and are leaders in their industries with strong moats. Of the two, I would have to go with KO in this case, though either would be a fine addition to a DRIP portfolio. While no one can dispute McDonald's is a great company that has grown a lot and has much growth ahead of it, at this time it looks like Coca-Cola is more attractively valued. While their p/e ratios are comparable, Coca-Cola has a price/book ratio of 4.69 vs McDonald's 7.74.

Another thing to like about Coca-Cola is their concentration. True, you don't get the instant diversification of a Johnson & Johnson or Procter & Gamble, but you do get a company that does one thing and does it well, and Coca-Cola has been doing it for the past 125 years (the new Coke formula fiasco of the 80's notwithstanding). They focus on beverages and related products whereas McDonald's not only competes with other fast food restaurants, but now also specialty coffee drink makers like Starbucks (NASDAQ: SBUX).

Over 70% of Coca-Cola's revenue is generated outside the United States with continuing growth in China and India, making it an excellent investment for international exposure. Coca-Cola has increased its dividend every year for the past 49 years, and while its ten-year dividend growth rate is 8.92% compared to McDonald's whopping 27.85% I would still have to go with Coca-Cola if I could only choose one or the other due to valuation, unit growth, and pricing power. It will be easier for Coca-Cola to grow its margins and pass on costs to its customers for its beverages than McDonald's can for its happy meals, and when inflation is factored in it's possible to pay the same amount for a Coke today as you would have 50 years ago. While both companies are subject to inflation of commodities, Coca-Cola has fewer to be concerned with than McDonald's, mainly water and sugar.

Yet another consideration is how often consumers are likely to buy each company's products. Sure, there are people that eat McDonald's everyday or more often, but that number is not likely to be as great as the number of people drinking Coke, Diet Coke, Dasani, Minute Maid, Vitaminwater, or any of Coca-Cola's other more than 3,500 beverages several times a day everyday. You may not get rich overnight starting a DRIP with Coca-Cola, but you will be able to build wealth slowly over time by adding this investment to your portfolio, and that is what DRIPs are all about.

When looking to invest in DRIPs, the best place to look once you've found a company you're interested in is the company's Investor Relations page, which is usually found on the company's main website or their corporate site if they have a separate one for that purpose. The Investor Relations page should have all the information regarding its stock, dividends, history, filings, etc. It should also have the company's DRIP information, if it has a DRIP, and its transfer agent if the DRIP is not available directly through the company like Procter & Gamble's.

Coca-Cola's DRIP is managed by transfer agent Computershare.com and has a minimum initial investment of $500 for one-time investments or $50 for recurring investments of at least 10 transactions. There are fees involved so you'll want to read all the plan materials thoroughly before pulling the trigger, but this should be a good one for the long term. (You can view the plan's materials here. McDonald's also has a DRIP with Computershare which you can view here.) Coca-Cola pays out its dividend April, July, October, and December. While this isn't ideal for receiving dividends every month of the year, it's far better to invest in a good company because it's a good investment than just for the time of year it pays out its dividend.

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