What is Dividend Reinvestment?
When a company declares a dividend, it takes profit that it has earned during the year and redistributes the funds to investors based on the number of shares they hold. Some companies offer a "dividend reinvestment" plan. These plans take money earned through the dividend disbursement and purchase additional shares or partial shares of the company for the investor.
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Dividend Yields
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Investors who use dividend reinvestment programs often use the "yield" as a way to measure a company's dividend. The amount of a dividend is calculated by dividing the annual dividend by the price of the share. For instance, a stock that costs $10 per share and releases a $1 dividend each year would produce a 10 percent yield. Typically, the higher the dividend, the better.
Advantages for the Shareholder
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Dividend reinvestment presents several advantages for the investor. To begin with, the programs offer an easy way to increase holdings and compound an investment. Dividends are reinvested in a stock and that, in turn, produces more dividend income. This continues with each dividend received.
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Advantages for the Company
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Companies that offer a dividend reinvestment plan tend to attract stockholders who are long-term investors. A group of dedicated stockholders creates higher demand for the stock and generally higher stock prices. In poor market conditions, this can also create stock price stability compared to other companies that are supported by more speculative investors.
How To Set Up a Dividend Reinvestment Plan
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The first step to establish a dividend reinvestment plan is to check if a company offers a plan. A number of companies offer direct investment plans that automatically reinvest dividends. If the company doesn't offer a plan, you can sign up with a broker who will reinvest dividends.
Fees and Commissions
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Fees and commissions on reinvested dividends can eat away at some power for a plan to compound your investment. You should check what types of fees and commissions are charged by your broker, or by the company's investment plan administrator.
Signs of Good Dividend Reinvestment
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Invest in a company's reinvestment plan if the stock has stable, sustainable earnings and dividends. Also, check the stock performance of a company. A stock with solid growth makes its dividend reinvestment plan even more tempting. Finally, low commissions and fees--or, best of all, free dividend reinvestment--should weigh in the decision.
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