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 The money or the stocks? - Eureka Report Article 


February 25, 2008

The money or the stocks?
By Scott Francis

PORTFOLIO POINT: Offers to be given more shares in place of dividends might be tempting, but investors need to weigh up the arguments for and against.


This time of year is a nice reminder of one of the key benefits of owning Australian shares: the income and franking credits that start to roll in. In a time of significant volatility in sharemarket values, it is nice to remember this key benefit of owning shares: potential exposure to a growing and tax advantaged income stream.

Many companies offer a "dividend reinvestment plan", where rather than take dividends as income, the investor can choose to take the dividend as more shares. This article compares the two ways of receiving income; should you take income as dividends or as extra shares? Right from the start, however, it should be noted that this is not a crucial investment decision. Deciding to dividend reinvest or not will not be the difference between a retirement of lobster and first-class travel, or one of Spam and travel limited to the odd shuffle around the block.

My own leaning is to take dividends as cash, but there are arguments both ways and we start by looking at the arguments for dividend reinvestment. (To find out which Top 100 companies offer a dividend reinvestment program, see the table below.)

Before we do that, I just wanted to clarify one misconception that I occasionally come across with dividend reinvestment, the idea that dividends are not taxable when taken as part of a dividend reinvestment program. This is not correct. The dividend is taxable as income whether it is taken as cash or dividend reinvested. There is no difference here at all.


The case for dividend reinvestment

The first argument is the no-brokerage argument. I have never seen a dividend reinvestment scheme that charges brokerage, and therefore it is a cheap way of buying additional shares. This could be particularly attractive if you have a small parcel of share that you wish to grow over time. It is worth keeping in mind that many discount brokers offer trading for $20 or less so the benefit might not actually be that great in dollar terms.

The second argument is that shares in a dividend reinvestment program are sometimes issued at a small discount to the market price. There is an attraction in buying an asset at less than market price.

Third is the reinvesting-for-growth argument. Long-term investors looking to grow the value of their investments over time might regard capital growth as far more important than dividends. Therefore dividend reinvesting - where they are actually buying more units every six or 12 months - helps meet that goal.


The case against dividend reinvestment

The number one issue that I see against dividend reinvestment is that you forfeit your ability to control the timing and price of your investment. Opting into a dividend reinvestment programs is to say that at the time the dividend is paid you will be happy that the best investment option available is the company you are dividend-reinvesting with, at the price set by the program. I would certainly not argue against reinvesting the dividend into your portfolio; rather I would argue against giving up the control that you do by investing through a dividend reinvestment program.

The "balance of the dividend" argument is another against dividend reinvestment. When a dividend is received, you will receive a number of shares. However, the amount of the dividend will not exactly equal the number of shares. Let's say that you received a $42 dividend and shares in the company were $4 each in the dividend reinvestment plan. You would receive 10 shares, with the $2 carried forward until the next dividend reinvestment plan. This is not a big deal if you miss out on $2 shares, but if you had Commonwealth Bank shares trading at about $50, you could miss out on getting $49 of the benefit from the dividend if you just missed out on being able to buy an extra share.

There is another twist here. Telstra's Summary of the Dividend Reinvestment Plan document says if Telstra's dividend reinvestment plan is cancelled or suspended at any time, "the company will donate any residual balance at the time ... to a charity ... approved by the board". Others do refund the money to you. This is something worth checking in the dividend reinvestment rules.

Record keeping is another argument against dividend reinvestment. If you dividend reinvest twice a year, for 10 years, you end up effectively buying 20 parcels of shares. This creates a reasonable bundle of paperwork that you need to keep your eye on. That said, the online record keeping from the share registries used by most companies keeps improving and can really help with this.

The last argument that I would put forward against dividend reinvesting is the "enjoy your dividend" argument. This is an argument that I would make for younger investors, suggesting that because the investor has been disciplined enough to invest some money they should enjoy the dividend paid to them it's a sort of positive feedback loop for the profitable behaviour of investing for the long run. After all, if you can become enthusiastic about investing for strong passive income streams early in life, that is a big step toward being financially successful.

As well as these arguments on an individual level, there are corporate finance arguments about dividend reinvestment at a company level.


Corporate finance effects

The 2007 annual financial report of National Australia Bank shows that almost six million shares (with a value of $200 million) were issued in 2006 under the dividend reinvestment program.

This affects all shareholders in the bank. Extra shares issued to pay dividends tend to dilute everyone else's ownership stake in the bank, and all future earnings have to be divided among more shares. Any shareholder who does not dividend reinvest has their ownership of the company slightly diluted.

There are people who argue that having to pay a cash dividend is a good financial discipline on a company. They argue that only a company with a good cash flow can afford to pay strong dividends. Dividends, it might be said, are a way of "keeping the bastards/boards honest".


Telstra, the Future Fund and dividend reinvestment

Another interesting corporate finance use of dividend reinvestments can be seen with Telstra's dividend reinvestment plan. Rather than issuing more shares for their dividend reinvestment plan, Telstra "expects to source the shares ... from the Future Fund'. (For a summary of dividend reinvestment plan, dated July 2007, see Telstra's website.)

Effectively the Future Fund is selling down its stake of Telstra over time through the dividend reinvestment plan. There is no discount offered to investors who are dividend reinvesting, so effectively the Future Fund is selling these shares at market value. This is a clever use of a dividend reinvestment plan to meet the Future Fund objectives of selling down its large holding of Telstra shares.


Direct deposits or cheques?

Another question around dividends for private investors is whether to have them paid directly to a cash account or to take the dividend as a cheque. Telstra led the way a few years ago by only paying dividends by direct deposit. Senator Kate Lundy, as part of a Senate estimates committee, asked Telstra how much money was saved by directly crediting dividends, rather than a cheque. The answer was that "it costs approximately seven times as much to pay a shareholder by cheque as it does by direct credit. The direct credit of dividend payments into shareholder bank accounts saves approximately $1 per shareholder."

The arguments for direct crediting of dividends include that:
  • It does save the company some money (and as shareholder and part-owner of a company you benefit from that).
  • You get the money into your account more quickly, and earning interest for you (no waiting to go to the bank, waiting for the cheque to clear, etc).
  • There seems to be less of a chance that things will go wrong: less chance of a lost cheque (or the cheque going through the wash - a personal favourite of mine).

Conclusion

To dividend reinvest or not to dividend reinvest? It depends on your circumstance but don't make the mistake of blithely signing a DRP for every share ever time; it may seem convenient but you need to ask yourself: Would I buy these shares? In a climate where cash is highly prized (and returning 7% risk-free) the argument that it's cheap hardly holds water any longer when you can do stock market trades for much less than $50 with discount style online traders.

The A-Z of DRPs
Company
Code
DRP
Company
Code
DRP
AFIC Ltd
AFI
Yes
Jubilee Mines NL
JBM
No
AGL Energy Ltd
AGK
No
Leighton Holdings Ltd
LEI
No
Auckland International Airport Ltd
AIA
No
Lend Lease Ltd
LLC
Yes
AMP Ltd
AMP
No
Lihir Gold Ltd
LGL
No
ANZ Ltd
ANZ
Yes
Lion Nathan Ltd
LNN
No
ASX Ltd
ASX
No
Macquarie Airports
MAP
No
AXA APH Ltd
AXA
No
Macquarie Communications Infrastructure Group Ltd
MCG
No
Alcoa Inc
AAI
No
Macquarie Infrastructure Group
MIG
Yes
Alumina Ltd
AWC
No
Macquarie Group Ltd
MQG
No
Amcor Ltd
AMC
Yes
Metcash Ltd
MTS
No
Aneka Tambang
ATM
No
Minara Resources Ltd
MRE
No
Aquarius Platinum Ltd
AQP
No
Mirvac Group
MGR
Yes
Argo Exploration Ltd
AXT
No
Mount Gibson Iron Ltd
MGX
No
Aristocrat Leisure Ltd
ALL
No
National Australia Bank Ltd
NAB
Yes
Asciano Group
AIO
No
Newcrest Mining Ltd
NCM
Yes
Babcock & Brown Ltd
BNB
No
News Corporation
NWS
Yes
BHP Billiton Ltd
BHP
No
Nufarm Ltd
NUF
No
Babcock & Brown IG
No
Oil Search Ltd
OSH
No
Bendigo Bank Ltd
BEN
Yes
Onesteel Ltd
OST
No
Bluescope Steel Ltd
BSL
No
Orica Ltd
ORI
Yes
Boart Longyear Ltd
BLY
No
Origin Energy Ltd
ORG
Yes
Boral Limited
BLD
No
Oxiana Ltd
OXR
No
Brambles Ltd
BIL
No
Paladin Energy Ltd
PDN
Yes
Commonwealth Bank Ltd
CBA
Yes
QBE Insurance Group Ltd
QBE
Yes
CC Hellenic Bottling Co. SA
CHB
No
Qantas Airways Ltd
QAN
Yes
CFS Retail Property Trust
CFX
Yes
Queensland Gas Co Ltd
QGC
No
CSL Ltd
CSL
No
Resmed Inc 
RMD
No
CSR Ltd
CSR
No
Rio Tinto Ltd
RIO
No
Caltex Australia Ltd
CTX
No
SP Ausnet
SPN
No
Coal & Allied Industries Ltd
CNA
No
Santos Ltd
STO
No
Coca-Cola Amatil Ltd
CCL
Yes
Seven Network Limited
SEV
No
Cochlear Limited
COH
No
SIMS Group Limited
SGM
Yes
Computershare Limited
CPU
No
Sonic Healthcare Ltd
SHC
No
Consolidated Media Ltd
CMJ
No
St George Bank
SGB
Yes
Crown Ltd
CWN
No
Stockland
SGP
Yes
Dexus Property Group
DXS
No
Suncorp Metway Ltd
SUN
Yes
Energy Resources Australia Ltd
ERA
No
Symbion  Health Ltd
SYB
Yes
Equinox Minerals
EQN
No
Tabcorp Ltd
TAH
No
Fairfax Media Ltd
FXJ
No
Tatts Group Ltd
TTS
No
Fletcher Building
FBU
No
Telecom NZ Ltd
TEL
No
Flight Centre Limited
FLT
No
Telstra Corp
TLS
No
Fortescue Metals Group Ltd
FMG
No
Toll Holdings Ltd
TOL
Yes
Fosters Group
FGL
No
Transurban Group
TCL
Yes
GPT Group
GPT
Yes
Wesfarmers Ltd
WES
No
Goodman Group
GMG
Yes
Westfield Group
WDC
No
Harvey Norman Ltd
HVN
No
Westpac Banking Corporation
WBC
Yes
Hutchison Telecommunications Ltd 
HTA
No
Woodside Petroleum Ltd
WPL
No
IAG Ltd
IAG
No
Woolworths Ltd
WOW
Yes
Incitec Pivot Ltd
IPL
No
Worleyparsons Ltd
WOR
No
James Hardie Industries NV
KHX
No
Zinifex Ltd
ZFX
No
Scott Francis' articles in the Eureka Report 

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