The best stocks for DRIP investing are high-quality, well-managed companies with a history of making dividend payments. Here’s how to find them.

Some dividend stocks give their shareholders the opportunity to participate in dividend reinvestment plans (DRIPs). This lets investors use their dividends to buy new shares, sometimes at a discount to the market price.

Discover characteristics of the best stocks for DRIP investing below, including a deeper look at the value of dividends.

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Understand how DRIPs work so you can determine the best stocks for DRIP investing

DRIPs let you save on commissions. DRIPs also eliminate the nuisance effect of receiving small cash dividend payments. Generally, investors must first own and register at least one share before they can participate in a DRIP. Registration will generally cost $40 to $50 per company. The investor must then notify the company that they wish to participate in its DRIP.

You can also register for dividend reinvestment plans at no cost through most brokers (these are called “synthetic DRIPs”). However, the broker may or may not pass along any reinvestment discount to you. As well, you can only buy whole shares through these DRIPs, so dividends paid must be greater than the price of one share.

DRIPs help dividend stocks attract more investors. They also let them conserve funds by issuing shares instead of paying out cash.

Look for these three traits so you can find the best stocks for DRIP investing

Don’t know where to start with DRIP investing? You should look first at our dividend stock recommendations. Here are a few indicators of dividend quality we look for:

1. High-quality dividend paying stocks should have a history of paying a dividend. One of the best ways of picking a quality dividend stock is to look for companies that have been paying dividends for at least 5 to 10 years. Companies can trump up quarterly earnings, issue press releases to appear to be making strong progress, but they cannot fake dividends. Dividends are cash outlays that an unsuccessful company could never produce. A history of dividend payments is one thing that all the best dividend stocks have in common, and one you’ll want to seek out if you’re interested in DRIP investing.
2. The best dividend stocks dominate their markets. We look for Canadian dividend stocks that have industry prominence, if not dominance. Our reasoning, besides brand recognition, is that major companies can influence legislation, industry trends, etc. to suit themselves. Minor firms can’t do that.
3. Be wary of dividend stocks with very high dividend yields. While they seem enticing for DRIP investing, they are often indicative of a stock that may soon cut its dividend rate.

Three points to bear in mind when looking for the best stocks for DRIP investing

Overall, we think that dividend reinvestment plans are okay to participate in. But we think there are a few important points to keep in mind:

• Many investors make their investment choices solely on the basis of the existence of the DRIP option. We think the availability of a DRIP is only a bonus, rather than a reason to invest by itself. Investing only in stocks that offer DRIPs limits both investment choice and opportunity.
• The advent of the low-cost discount brokerage and online investing has reduced the commission cost of investment trades. Thus, the commission-free investing that DRIP investing allows is less of an advantage today than it was in the past.
• Taxes are still payable on dividends that are reinvested.

Most companies that offer DRIPs provide details on their web sites. Another place to look for information is the inside back cover of most companies’ annual reports. You can also contact the investor relations department of companies you wish to invest in.

Don’t overlook the benefits of dividend-paying stocks for Canadian investors

At TSI Network, we’ve always placed a high value on dividend stock investing, mainly because it provides something of a measure of safety for stocks we recommend.

After all, as mentioned, you can’t fake a record of dividends. It takes a lot of success and high-quality management for a company to generate the cash necessary to declare and pay a dividend every year for five or 10 years or more.

We also recommend dividend-paying stocks because Canadian taxpayers who hold them are eligible for the dividend tax credit.

This dividend tax credit—which is available for dividends paid on Canadian stocks held outside of an RRSP, RRIF or TFSA—will cut your effective tax rate.

This means that dividend income will be taxed at a lower rate than the same amount of interest income. (Investors in the highest tax bracket pay tax of around 29% on dividends, compared to 50% on interest income. Investors in the higher tax bracket pay tax on capital gains at a rate of 25%.)

Use our three-part Successful Investor approach to find the best dividend-paying stocks

1. Hold high-quality, mostly dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight.

There has been company controversy surrounding some discount DRIPs, as they may lead to wealth redistribution between non-participating and participating shareholders. What are your thoughts on this?

What do you consider the biggest advantage of DRIPs?