The first time I was able to participate in a stock’s dividend reinvestment plan (DRIP) was in 2nd half of 2018.
The dividend reinvestment plan (DRIP) was offered by a real estate investment trust (REIT) listed in Singapore. Here was how it went:
Stockbroker: ‘Congrats! Mapletree Logistic Trust, a stock that you own is offering a DRIP’.
Stockbroker: ‘You may choose to receive your distributions in cash or in units of Mapletree Logistic Trust. Which of the two would you prefer?’
Ian: ‘What is the unit price offered under the DRIP?’
Stockbroker: ‘It is S$ 1.25 per unit.’
Ian: ‘I see. Let me get back to you on it.’
The question was: ‘Should I opt for DRIP or to receive my distributions in cash?’
A debate has taken place in my mind. I was excited to receive extra units of the REIT. But, at that time, I was also looking at another stock to invest. If I have my distributions in cash, I can use the proceeds to invest in that stock or to settle a handful of bills in-hand.
Today, if you are in my position one year ago, how would you choose? Would it be cash or shares? If you are not sure, in this article, I’ll share five key things on DRIP that you need to know before making a decision on it. They are as follows:
Why some stocks offer DRIP?
Let’s assume, I’m the Managing Director of a Public Listed Company and I run it successfully with strings of profits.
I can choose to retain its earnings in the company’s bank account. On the bright side, I have money to invest to expand my business. But, on the darker side, the company may lose its investment appeal to dividend investors. They might have billions of dollars in investment capital who wish to invest for steady income for the long-term. This includes pension funds, mutual funds, insurers, … etc.
I can choose to reward my shareholders with generous dividend payments. This is great to attract dividend investors who possess huge amount of capital. But, I would have less money to invest to expand my business. Ouch!
Thus, I may offer my shareholders with DRIP, which is a hybrid of the two. First, I can still attract dividend investors to invest in my shares as I continue to pay out generous dividends. Second, I can retain a large portion of these earnings in my company if they opt for DRIP. It allows me to have a lot more capital to invest for the future. Awesome!
DRIP = Dividend Payments (Attract Rich Investors) + Retain Capital
ROI Calculations for DRIP-Stocks
The total Return on Investment (ROI) of a stock that provides DRIP frequently is calculated a bit differently from a stock that does not. This is because, in a way, DRIP-stocks tend to enjoy slower capital appreciation than non-DRIP stocks over the long-term. This, I believe, is not a fair comparison.
Let me illustrate:
Let’s say, Stock A is a non-DRIP stock and had appreciated from $ 10.00 in Year 1 to $ 15.00 in Year 5. Normally, investors would conclude that Stock A has grown by 50% in capital appreciation in 5 Years.
Let’s say, Stock B is a DRIP stock and had appreciated from $ 10.00 in Year 1 to $ 14.00 in Year 5. Once again, it is a norm for investors to conclude that Stock B is one that has grown by 40% in capital appreciation in 5 Years, hence, did not do well when compared to Stock A.
That is not true. What if, I rephrase the two as follows:
Let’s say, Stock A is a non-DRIP stock and had appreciated from $ 10.00 in Year 1 to $ 15.00 in Year 5. It has paid out $ 0.50 in dividends per share (DPS) a year in the 5-year period. As such, if an investor purchased 1,000 shares of Stock A at $ 10.00 a share in Year 1, his investment would grow his capital into:
Capital (Year 5)
= (Stock Price x No. of Shares in Year 5) + Dividends Collected
= ($ 15.00 x 1,000 shares) + ($ 0.50 x 5 years x 1,000 shares)
= $ 15,000 + $ 2,500 = $ 17,500
Let’s say, Stock B is a DRIP stock and had appreciated from $ 10.00 in Year 1 to $ 13.70 in Year 5. It declared $ 0.50 in DPS a year and offered its DRIP to investors where they can receive extra shares at $ 10.00 a share. Let’s assume, it attained a take-up rate of 100% (all shareholders had opted for DRIP and not cash) and it has grown its share price to $ 13.70 in Year 5. Thus, an investor who has bought 1,000 units of Stock B at $ 10.00 a share in Year 1 would have first increased his number of shares to 1,276 in Year 5.
|Year||No. of Shares (start of year)||Dividends Declared ($ 0.50 a share)||Dividends (Amount)||DRIP ($10 a share)||No. of Shares (end of year)|
Capital (Year 5)
= Stock Price x No. of Shares in Year 5
= $ 13.70 x 1,276 shares
= $ 17,481 (close to $ 17,500, which is the same as non-DRIP stock above)
What’s the Catch?
There are three key considerations.
First, as stated above, you will receive odd units of shares (a number that is not equivalent to 100 units). The odd units are hard to be disposed of in the market transactions (buy / sell) are based on 100-unit basis.
Second, it is about flexibility. Cash is often preferred if you need it to pay bills or to fund another type of investment. Thus, if you intend to accumulate its stocks for the long run without selling it, then, DRIP is suitable for you.
Third, it is about the DRIP offer. What is its issue price? Is it a sound investment? It is helpful for you to have a target price of a stock. For instance, you may set a maximum target price of $ 10 on a stock. In other words, if it is trading below $ 10 (let’s say $ 8 or $ 9), you may consider taking up the offer. But, if the offer is above $ 10, then, you may choose to receive cash instead.
Referring to my experience above, I was offered S$ 1.25 an unit for Mapletree Logistic Trust, which was a 3% discount from its current market price. Did I take up the offer? Nope.
Why? This is because I bought MLT at S$ 1.01 per unit, which was close to 20% below the DRIP offer.
Is that a good move?
I think it is debatable. Today, MLT is trading at S$ 1.56 an unit. It means that if I took the DRIP offer, I would still achieve an awesome capital gain from it. In this case, you may say that I lost an opportunity to boost my returns from this offer.
But, on the other hand, I took my cash dividends to invest in another profitable stock (another good S-REIT) and achieved both capital gains and dividend yields from it. So, at the end, it is all well with me.
So the key here is if you are choosing cash for your dividend, are you planning to do something with that cash? If not, would you rather have more units in your existing investment?
Hope the above helps to answer whether or not you should take up the stock’s DRIP offer when it is offered to you.
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