DRIP Your Way to Riches

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Warren Buffett talks about compounding wealth over time, but many people wonder how exactly one does that. A Dividend Reinvestment Plan, or DRIP, is one such way. DRIPs are programs offered by many large companies to their shareholders. They enable shareholders to receive additional equity in lieu of a cash dividend (technically, the DRIP administrator issues a cash dividend and then automatically buys shares with the dividend without charging a transaction fee to the shareholder).

So, instead of taking the money and buying shoes or putting it in a savings account, DRIPs simply reinvest the dividends and slowly build a bigger position in the company. Through the magic of compounding, the more you reinvest your dividends, the bigger the dividends you will be given. Thus, your ownership of the company snowballs over time.

While many large companies offer DRIPs, I have selected five good companies with yields in excess of 2%. If you buy and hold these companies while reinvesting the dividends, you should do well over time.

ACE Limited

ACE (NYSE: ACE) is a global insurance and reinsurance company primarily in the Property & Casualty market. It currently sports a 2.5% dividend yield, compared to an industry-average 1.7% yield. One reason that ACE's yield is higher than that of other insurers may have to do with its crop insurance policies: the country is undergoing the worst drought since 1956, which has impacted crop output. ACE may have to pay out a lot of money in the future to make up for the losses.

Deere & Co

Deere (NYSE: DE) manufactures equipment for the agricultural and forestry industries. It currently yields 2.2%, compared to an industry-average 0.6%. Part of the discount is due to a higher payout ratio for DE, which is the mature industry leader. The company's P/E of 11 is in line with its peers. The long-run outlook for DE is positive, given a worldwide shortage of food that will lead to increasing commodity prices over the next decade.

Exxon Mobil

Exxon (NYSE: XOM) is an integrated oil company. Its dividend yield is 2.6%, which is only moderately higher than its normal yield. Most integrated oil companies pay a large dividend due to limited capital appreciation potential. Exxon is a blue chip stock that should serve buy-and-hold investors well in the long-term.

Norfolk Southern Corporation

Norfolk Southern (NYSE: NSC) is a railroad operator with operations based primarily in the eastern-half of the United States. It yields 3.4% vs an industry-average 1.3%. This is surprising given its superior profitability (high EBIT margin, ROE), but understandable given its limited growth prospects.

Target Corporation

Target's (NYSE: TGT) retail stores attract a slightly more affluent customer than Wal-Mart's, but they sell the same types of products. Target currently yields 2.3%. Over the last four quarters, Target has paid out $1.20 per share in dividends and reported $4.40 per share in earnings ($2.37 in free cash flow). In addition, the company has a strong history of increasing its dividend, and it is likely to continue to do so in the future.

Conclusion

Dividend yield is only one part of the investor return equation; it is important to evaluate the price of the stock in relation to its intrinsic value before buying. However, buying a company near or below intrinsic value, and reinvesting the dividends via a DRIP plan, will allow you to compound your wealth at a high rate over time.


titans8904 has no positions in the stocks mentioned above. The Motley Fool owns shares of ExxonMobil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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