Growing Your Shareholding On Dividend Plough Back

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Any takers?

http://www.businessdayonline.com/
February 7th, 2007
Growing your shareholding on dividend plough back


Dividend Reinvestment Plans (DRIPS) is a concept that is being marketed by capital market operators. The investor’s shareholding is boosted, while the company gains access to cheap cash, writes
Chinedu Dike

Market information about dividend-cash dividend or bonus issue - immediately drives up the market price of the shares of a company. It is very common to hear shareholders making a demand on the board for cash dividends or bonus issues. Where the company decides to reward the investors with cash, there is an outflow of investible funds from the company. A bonus issue on the other hand would enhance individual investor’s stock holding, while the firm retains the cash for future growth.

Dividend Reinvestment Plan adequately provides a meeting point between these two demands. Capital market operators and investment experts have consistently argued that rather than ask for cash dividends, shareholders should ask for bonus issues or better still, build a reinvestment plan that would over the years increase their stock holding to gain better control in a company.

Modupeola Dada, managing director and chief executive officer, Prominent Securities Limited, had queried, "why should shareholders consistently ask for cash dividends? This is the money the company needs to grow. They should instead demand for bonus shares which they would sell and still get the cash without jeopardizing the liquidity of the company."

Desmond Obienu, an investment banker noted, "the current trend is investors having and managing a dividend reinvestment plan in which their cash dividends are either reinvested in the company initiating the dividend on in any other company they may wish to invest in."

Dividend Reinvestment Plans

or DRIPs, are a way for shareholders to reinvest variable amounts in a company over the life of a long-term investment. By reinvesting dividends, shareholders can purchase additional shares of same company paying the dividend or some of publicly-traded companies at a time. Instead of giving the investor a quarterly dividend check, the entity running the DRIP (the company, transfer agent or brokerage firm) uses the money to purchase additional shares of the company in the name of the investor.

If the company itself is operating the DRIP, it will set specific times in the year when the purchase of shares by shareholders in its DRIP programme is allowed. The company itself does not go into the secondary market and purchase the shares and then sell them through the DRIPs. The shares sold through the DRIP are taken out of the company’s share reserve. DRIP shares cannot be sold on the market; when investors are ready to sell their DRIP shares, they must sell them back to the company that issued them at the current market price. If the DRIP is operated by a brokerage firm, the firm simply purchases shares for you from the secondary market and adds the shares to your brokerage account, and these shares are eventually sold back on the secondary market.

Investor benefits

• Company-operated DRIPs are commission-free because there is no broker required to facilitate the trade. This feature is very appealing to small investors, who otherwise would have to save up funds for an extended period of time in order to make the typical brokerage commission fee a small enough proportion of their purchase amount.

• Some DRIPs offer optional cash purchase of additional shares directly from the company, usually at a 1-10 percent discount and with no fees attached.

• DRIPs are flexible by nature. Investors are able to invest large or small amounts, depending on their financial position.

• DRIPs use a technique averages out the price at which you buy stock as it moves up or down over a long period. Using this system, you are never buying the stock right at its peak or at its low.

• Some DRIPs offer stock at a discount from its spot price in the market. Discounts can range from as little as 1 percent to as much as 10 percent. When combined with no commission fees, the cost basis of these shares for an investor can be considerably lower than it would be if he or she purchased outside of a DRIP.

Company benefits

You may be wondering why a huge company would concern itself with selling a couple of shares here and there. For the company, the advantage is that DRIPs offer low-cost access to capital. When you purchase a stock on an exchange, you are buying it from another investor, so the company sees no benefit from the sale. DRIPs are different. The DRIP shares are bought directly from the company and the proceeds are then reinvested into the company.

Companies also like DRIPs encourage a stable shareholder base that typically has a long-term investment style. DRIP investors are unlikely to run for the exits when the markets start to sour, partly because DRIP shares are less liquid than shares in a regular brokerage account or shares in the secondary market and selling them takes a little more time and effort than just calling a broker. Remember, if the shares come from a company-operated DRIP, they need to be repurchased by the company - this does not allow for the kind of easy sales found in the general stock market.

Types of DRIPs

Due to the increasing popularity of this investing technique, more and more companies are setting up DRIPs, but not all plans are set up and run in the same manner. Companies that operate the DRIPs themselves will have their investor relations department handle all aspects of the plan, sometimes even allowing individuals to buy a share of the company (to start a DRIP account) directly from this department as opposed to from a broker. While some companies run their own plans, others find the costs too great and use third parties, or transfer agents, who act on behalf of the company and handle all of the company’s DRIP details.

A third alternative for investors is a DRIP set up through a brokerage. Because not all companies have a dividend reinvestment plan set up, some brokerages will recognize this void and allow investors to reinvest dividends at no cost, essentially simulating a DRIP. However, be aware that these brokerage-run plans only allow for the reinvestment of dividends and offer no cash purchase option. And keep in mind that brokerages are out to make money too, and they will only provide this service for customers who also use their account to make commissioned trades.

Getting Started

Starting a DRIP account requires a little legwork from the investor. First off, you must research which companies have DRIPs, as not all do. Find out which firms have DRIPs ecluding those run by brokerage firms, and what the terms of these accounts are. Once you know that your desired company has a dividend reinvestment plan, you must determine who runs the plan - the company or a transfer agent? Next, you’ll have to buy shares in the company to be able to set up the account.

In order to qualify for a DRIP, the shareholder is often required by the company that operates it to have his or her name registered on the share certificate. Shares held in a brokerage account are very rarely registered in the shareholder’s name and are instead registered in street name. This cuts down on the company having to phone brokerage firms to confirm ownership.

The specific characteristics of DRIPs can vary from company to company. For example, some companies allow shareholders to buy shares based only on their dividends, while others allow optional cash purchases on top of the dividend reinvestment. So make sure you do your research before signing up for a DRIP.

Taxation

Another misconception about DRIPs is that they are not subject to tax because the investor is not receiving a cash dividend per se. In fact, while DRIPs are beneficial for their cost-effective approach to investing, they are still subject to tax. Because there was an actual cash dividend, although reinvested, it is considered to be income and thus taxable. And, as with any stock, capital gains from shares held in a DRIP are not calculated and taxed until the stock is finally sold, usually several years down the road.

The DRIP is a fairly new phenomenon that benefits investors and companies alike; being familiar with DRIPs may bring value to your portfolio.



DRIPs however, has some disadvantages as it is more difficult to resell if it managed by the company issuing it. It is also more expensive for a company to maintain a department that would be solely responsible for managing the plan at supposedly no charge on the investor. An option in this case would be to outsource the function to a brokerage firm at a fairly favourable terms that would not defeat the objective.