Many companies offer dividend reinvestment plans, or DRIPS, which automatically invest dividends into additional shares of the company's stock. These plans allow you to accumulate more and more shares over time at varying prices, thus increasing your dividend payment at a greater rate than just the dividend growth itself. How much of a difference does setting up a DRIP really make, though? I'll look at three companies which have been reliably paying dividends for many years, Johnson and Johnson (NYSE:JNJ), Verizon Communications Inc. (NYSE:VZ), and McDonald's Corporation (NYSE:MCD), and show why reinvesting dividends can be a smart move.

The Setup

For each of these three stocks imagine that you bought $10,000 worth of shares at the beginning of 2003. Each time a dividend is paid you buy new shares at the closing price on that day. I'll use the ex-div date instead of the actual payment date since Yahoo Finance has historical ex-div dates readily available. After a decade of this you now have more shares than you started with. I'll compare the results from this scenario with one in which you don't reinvest the dividends and simply keep them as cash.

Johnson and Johnson

Johnson and Johnson has been a reliable dividend stock for decades. At the beginning of 2003 the stock was trading at about $55 per share and paying a $0.205 quarterly dividend. The stock currently trades for around $74 per share and pays a $0.61 quarterly dividend. The stock price has increased at an annualized rate of just 2.29% in that time while the dividend has grown by a much faster rate of 11.52% annually.

Here are the results of the two scenarios for Johnson and Johnson:

If you had simply kept the dividends in cash you would have collected a total of $3,076 in dividends over the past decade while your stock would have risen in value to $13,336, a total collective value of $16,382. Reinvesting the dividends would put the total value at $17,516. This doesn't appear to be a huge difference from the graph, but your portfolio would be worth almost 7% more simply by reinvesting the dividends. On an annualized basis, keeping the dividends leads to 5.06% annual growth rate while reinvesting them leads to a 5.77% annual growth rate.

A more pronounced difference is that by reinvesting the dividends you now have 31% more shares. Your annual dividend payment is about $580 compared to just $441 from keeping the dividends. Here's the annual dividend payments over time for both scenarios.

Verizon

Being a telecom Verizon pays a high-yield dividend, currently around 4.8%. At the beginning of 2003 Verizon was trading at $40 per share and paid a quarterly dividend of $0.385. Currently the stock trades for about $42.50 and with a quarterly dividend of $0.515. The stock has been essentially flat while the dividend has increase by about 3% annually.