In a town where I used to live, there was a carpet retailer who ran annoying ads, shouting that “No sale beats wholesale.” Corporate America isn’t about to shout that message, but a lot of stock investors just might.
Industry watchers are expecting a boom in the number of companies that sell shares directly to the public, without the need for a broker, in the second half of the year. In February alone, eight new companies unveiled direct-purchase plans.
That may not sound like a lot, but it’s huge growth when you consider that only 92 companies now offer such plans (though some sell only in one state, or in the case of utilities, just to their customers) and that just 55 offered direct purchases a year ago.
“There are some very significant household names about to do this,” says James J. Volpe, vice president of First Chicago Corp., a stock transfer agent that helps corporations implement both direct-purchase and dividend reinvestment plans. “By next January, there will be 500 to 600 plans. Honestly, there is just going to be a rush. Companies are now at the point of saying `Why shouldn’t we offer this?’ instead of `Why should we?’ “
To individual investors, a direct-purchase plan or a dividend reinvestment plan is like buying that carpeting at a wholesale price. There is no cost of dealing with a middleman–a broker–so buying direct is like getting a sale price on a stock.
“Open enrollment,” or direct-sales programs, have been around for years, but never gained widespread acceptance because companies had to scale tall hurdles to get regulatory approval. Last year, a lot of those stumbling blocks were eliminated.
Though the terms are sometimes used interchangeably, open enrollment differs from typical dividend reinvestment plans, or DRIPs, which require that an initial stake be purchased through an intermediary and allow for subsequent purchases direct from the company. The number of DRIPs hovers in the 850 range.
Of course, forecasts for an explosion in what some professionals call “no-load stocks” have been around for more than a year, since the SEC streamlined the approval process. Things have picked up, but investors haven’t seen the boom.
Most industry watchers believe such expansion is inevitable given the growth of no-load mutual funds, where the public invests directly with the money manager. In fact, the popularity of mutual funds has made some firms start to explain their actions in terms a fund investor would understand.
In a report to shareholders last year, for example, Coca-Cola, which is widely rumored to be one of the big names set to unveil an open enrollment plan this year, compared its operations to the holdings of a global mutual fund.
“Investors have gotten to the point with mutual funds where they feel comfortable investing on their own, and they want the same freedom in stocks,” says Charles Carlson, publisher of The DRIP Investor, a newsletter that tracks both open enrollment and dividend reinvestment plans. “And the companies want these investors because they tend to become long-term shareholders.”
But the growth in these plans does not come without its costs. For years, investors considered DRIPs and direct-investment options as the proverbial free lunch.
Now companies are instituting fees that are worth considering before enrolling. Typically, these fees represent the corporate effort to make sure that all shareholders don’t foot the bill for services to the small group of direct investors, or to pay for new services, such as phone redemptions, offered in the open enrollment plan.
McDonald’s, for example, has three levels of fees, starting with a one-time $5 setup charge, then a $3 annual account administration fee and, finally, a small charge for buying additional shares.
The cost of buying more shares is $1 plus an additional 10 cents-per-share for investors who make automatic monthly withdrawals from a checking account, or $5 plus the 10 cents-per-share charge for investors who send in a check. The automatic withdrawal fee is capped at $6, with the check-writing charges topping out at $10.
While it seems like small potatoes, those numbers are not inconsiderable. A $100 check, for example, would buy about two shares and result in a total fee of $5.20, or 5.2 percent.
On a percentage basis, that’s a high tariff for getting in. In real dollar terms, however, an investor could not make a trade that small without paying a much higher commission, even with the deepest of discount brokers.
And with the caps making sure the fees never exceed $10, the direct option is virtually guaranteed to remain cheaper than anything a brokerage house can offer.
“Some people were bummed out when companies started putting in fees,” says Carlson, “but they are losing the forest through the trees if they are unwilling to pay $5 for McDonald’s stock, but will buy some crappy stock that doesn’t charge anything. The important thing with any of these plans is whether the stock is a good buy and can be acquired economically by a small investor.”
Where the fees can make a difference is with DRIPs, where some companies now charge brokerage-like commissions. When reinvesting dividends with Bristol-Myers Squibb, for example, shareholders pay 4 percent of the purchase amount, up to a total of $5. Additional investments get ticketed at 4 percent, up to $25. A $100 dividend and $500 additional investment, therefore, would cost $29.
“Right now, the charges still tend to be less than what someone pays for a broker, but if the trend is toward more fees to cover the costs of these plans, then you could get to a point, on some plans, where the DRIP is not the most efficient way to buy the stock,” says Sumie Kinoshita of Evergeen Enterprises, which tracks the DRIP business. “But we haven’t seen much of that yet.”
Investors new to direct-purchase plans should also know that not all DRIP plans are alike. A number of discount brokerages offer what they describe as “no-fee dividend reinvestment programs,” which really are not worthy of the genre. The best part of being in a DRIP is not the reinvestment of dividends–typically a small amount of money–but the direct stock purchases allowed once initial shares have been purchased.
Most of the company-sponsored DRIPs allow reinvestments of as little as $100, and many will take as little as $10 a month. The brokerage programs most likely would refuse those amounts, and would charge a commission on the new shares, too. To explain how they get away with that means going into some arcane details, but suffice it to say that brokerage-sponsored DRIPs should be approached with skepticism.
