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Investing

Why I Don’t Like DRIPs

What Is A DRIP?

A DRIP is also known as a DRP and stands for Dividend ReInvestment Plan / Programme. It is a way for company’s to offer shareholders a dividend in the form of money, equity or a combination of the two, at the choice of each shareholder.

The Advantages Of DRIPs

Company’s can offer shareholders a dividend or equity. This is a good way to raise capital for the company because the value of the company is set to the market rate (usually a 2% discount), while a capital raise (CR) tends to be at a bigger discount because investors have to be enticed to invest and the increased supply of shares lowers the value of the CR, causing more dilution to existing shareholders.

Why I Don’t Like DRIPs

I don’t like DRIPs because the amount of money raised is uncertain, so it’s not a good way for a company to plan usage of funds, which means the money raised (or rather retained) doesn’t get spent efficiently. If it was determined that capital was needed, it’s better to know how much, then use financial models to determine that the investment will give greater returns than the dilution. If money is perpetually useful to the company for growth, then it would be better to financially model CRs so they can be most efficient in terms of growth vs. dilution and also plan the risk of the investment in appropriate stages of approach.

My other problem with DRIPs is that (unless the company is an investment vehicle such as a managed fund) the company is not an investor. What I mean by that is that it’s the company’s job to run the company and an investors job to be in charge of their own investments. When the dividend is made available, the DRIP might not be the best place to invest at the time, so it’s unreasonable for a company to instate a DRIP to satisfy those shareholders who don’t want a dividend vs those who do. This is because the tax implications are the same and it’s not ideal to forcibly dilute shareholders who have better places to invest their money.

Finally, I don’t like to invest in DRIPs because it removes my ability to choose the best time and place to invest my dividends. Taking the market value at whatever price it might be relies on other investors to determine the price and therefore value of my investment. This is bad because what is a good investment for one investor might be a bad one for another. For example, an investor might pay a higher price for security, while another might not value security as much and find such an investment expensive. This concept is evident by the fact that different stocks find different prices based on different valuation algorithms – otherwise it wouldn’t matter what stock you bought as long as you diversified, which clearly isn’t the case.

The Exception To The Rule

Arguably DRIPs have a place in Exchange Traded Funds (ETFs) as the investor effectively hands off their role as investor and the company they buy into manages that role instead. The ETF would want to offer a dividend so it can be used as a passive income (otherwise hands off investors would need to actively manage their holding to create an income, which doesn’t make sense if you’re buying a managed investment).

The ETF would also want to give people a way to passively reinvest to grow their savings. In this case a DRIP is ideal and there’s also the benefit that as reinvested dividends would increase the value of the fund in a fungible fashion; investors taking the dividend are effectively not diluted because they still own the same amount of value in the fund.

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