Dividend Reinvestment Plans (DRPs)

By Sandy Naidu | December 15, 2008

A lot of companies offer cash dividends to their shareholders. But some companies give their shareholders the option of either taking up the cash dividend or the option of purchasing some additional shares in the company. It is totally up to the shareholders - they can either take up the dividend or get some additional shares in the company. These shares are offered at a discount to the current market price. This method of offering shares for dividends is called Dividend Reinvestment Plan (DRP).

Key Points To Be Aware When Considering DRPs

1. You are getting the shares at a discount to the market price. This is good if the shares of that company are currently undervalued or optimal. On the other hand, if the shares are currently overvalued then opting the additional shares over the cash dividend might not be a sound option.

2. With DRPs there is no temptation to spend the cash dividend that you would have otherwise got. You are investing the money back. And soon you will start receiving dividends on dividends.

3. With DRPs you are getting additional shares without paying any brokerage fees.

4. ATO treats DRPs as if you had received a cash dividend and then used the cash to buy additional shares. So you have to declare the dividend amount in your annual tax return as income. And the shares you bought using this plan will be subjected to Capital Gains Tax (CGT) at the time of selling.

5. Whether you take up DRP or not depends a lot on your initial goals/motives when buying the stocks. If you bought it for the dividend income then you need the dividend. But if you bought them to gain from long term capital appreciation then DRP might suit your investment needs better.

6. With DRP you are investing into the same stock again. Some you could say that it it not helping you to diversify your portfolio.

7. Lately a lot of companies have been issuing DRPs. The times have been tough lately and companies are finding it tough to raise capital. But some of these companies, on the pretext of declaring dividends, are also issuing DRPs. A lot of investment pundits are saying that by declaring DRPs, these companies are diluting the shareholding of the existing shareholders.

So before you take up a DRP, consider the pros and cons - don’t just fall for them because they are at a discount to the market price. On the same token some them could be a bargain…Evaluate it properly (as if you are making a new investment decision).

If you have thoughts and opinions about DRPs, leave a comment below and share it with all of us.