Back when DRIP programs were rolling out in the 1960s and 1970s, one of the advantages typically offered in such programs was a 5%, 10%, and in some rare cases of budding blue-chips, 15% discount on dividend reinvestment for those investors holding the stock.
The whole point of it was to encourage and incentivize people for thinking like long-term business owners. Also, it was a way to shift the accumulation of company stock away from the folks in New York that tended to want results now towards a more genteel and understanding owner base that would be patient with management when business conditions thwarted companies from achieving expected growth. This was a strategy pioneered by Richard Joshua Reynolds (the Emory graduate who owned the RJ Reynolds tobacco company) who hated Wall Street folks buying up bits of his company and used the promise of special cash payout structures for employees and small-time investors to make Winston-Salem, North Carolina the seat of Reynolds Tobacco’s power.
But, with the advent of discount trading, companies have generally abolished their discounted dividend programs because people aren’t really programmed anymore to hold blocks of stock for a super long period of time. Think about it: When’s the last time you’ve encountered someone who has held the exact same stock without selling it for ten years? Fifteen years? Twenty years? You used to have things like stock certificates, phone calls to brokers, and high trading costs which would force you to pause and think, “Oh right, I’m dealing with real, honest-to-god companies here.” But that friction is gone. When you combine widespread financial illiteracy in schools with the ability to trade stocks whose sole tangible existence is the letter “V” or “JNJ” or “KO” on a computer screen, and then combine that with do-it-yourself trading for $8.95, you create a “Culture of Death” as far as buy-and-hold investing is concerned.
That’s why, as a matter of my personal view, I think dividend discounts are more useful than ever. It’s a shame they’ve become a relic, about as unusual as finding an actual member of the clergy teaching at a religious high school. One company, though, seems to be holding on to the notion of rewarding long-term investors by giving them a discount on dividend reinvestment. And that is Aqua America, a northeastern water utility that uses its superior distribution network to execute a growth-through-acquisition strategy that tends to reward shareholders with the patience to stick with it.
Water utilities definitely the sexy part of the investing world, but they show what happens while you take a 3% dividend yield, and grow the business by 7-9% over the long-term (and turn that business growth into dividend growth), and then give shareholders a 5% discount on those reinvestment.
Over the past twenty years, a $10,000 in Aqua America has turned into $129,000 worth of the water utility’s stock. What I find interesting, though, is that the money didn’t really get made by increases in the share price. Rather, it was the dividend payout that then bought you more (discounted) shares which then started paying out dividends of their own that is responsible for a large chunk of the company’s growth.
If you had just taken your Aqua America dividends over the past twenty years and spent them, your 563 shares would have only grown to $92,000+ for a total return of 824%.
If you reinvested your dividends, however, your share count increased from 563 to 5,117 shares and became worth $129,000 for a return of 1,191%.
The 5% discount is something that is hard to notice in the early days (as are most things when it comes to compounding). But once you’re that person with 5,117 shares, the discount policy starts to matter. The current price is $25.21. During the next $777.78 payout for our investor, he’ll be able to reinvest at a price of $23.95. That will net him 32.47 shares instead of 30.85 shares like you’d get anywhere else. Now, those additional 2 shares will start paying out $0.152 quarterly dividends, which will themselves get discounted. When this is applied every ninety days for decades on end, you start to see nice windfall rewards for being a long-term shareholders. It’s nice that Aqua America takes care of those owners that stick with the company year after year, decade after decade.
Originally posted 2014-04-07 06:00:12.