Forum Archive Index - June 2002

["tennyson@caverock.net.nz" <tennyson@caverock.net.nz>]

Hi terry,

>
>so  your saying it is a great investment at this time 
>for the DRIP investor.
> 


Actually I think it would be a very bad idea to get involved in any 
Wrightson dividend reinvestment plan.   But that is because I am not 
in favour of dividend reinvestment plans at all for 'income' shares.  
My logic is as follows.

Dividend reinvestment plans are a way to build up your shareholding 
in a company by accepting new shares instead of a cash dividend.  The 
strike price of these shares is normally set based on the market 
price of the shares, typically based on some sort of average price in 
the days before the dividend is due to be paid.

When DRIPs first became available in New Zealand, typically a 
discount was offered on shared issued under such a plan.  This was 
sometimes as much as 5% of the prevailing share price.  These days 
the discount in such plans has been reduced to 2%, sometimes even 
less.  It is this low discount factor that kills these schemes for 
income share investors.

For the purposes of this discussion, we'll define an income share as 
something that has a gross yield (before tax) of 6%  (6% is roughly 
what you might expect from having a term deposit in a bank).  Let's 
assume this dividend is paid out twice per year in two 3% chunks.  In 
the months before this payout, our theoretical 'income' share (which 
has a share price 'chart' that is a horizontal line) will ramp up 
slightly above its baseline level to take account of this coming 3% 
dividend.  Immediately after the dividend entitlement expires, the 
share price will drop back to its 'flatline' level (the 3% dividend 
being paid).  Now do you see the problem with this for our 'income' 
investor?

The problem is that the shareprice has been ramped up because of the 
dividend by 3% at the very time the price for shares in lieu of 
dividends is being set.  So far from getting a real discount of 2% on 
the shares issued, our income investor is getting a discount on the 
inflated (by 3%) price of the shares just prior to dividend payment.  
If we allow for this the actual price of the shares issued compared 
to the shares flatline base level is:  

0.98x1.03x(base level)= 1.009(base level)

In other words our DRIP shareholder is not getting the shares at 
a discount to the market.   They are actually paying slightly *more* 
than market price (in this example)!  

In the case of Wrightson shareholders about to get a 7% payout per 
share in August, the dividend yield is much higher than 6%.  This 
means that any shares issued under a Wrightson DRIP, averaged on the 
share price five days before the ex-dividend date, and issued at a 2% 
'discount' (sic) will really be getting their shares at:

0.98x1.07x(base level)= 1.05(base level)

These shares will be issued at a price *5% more expensive* than if 
the shareholders had waited until the dividend was paid and then 
bought the shares on the market using cash!  Of course being an 
income investor our shareholder would need to sell his issued newly 
shares to satisfy his income requirements.  He would then have 
brokerage deducted from the shares he sold.  This means that the 
after fees cost of the new shares he has acquired is even more than 
5% above the market price! 

This is a terrible result, and this is the reason I think that 
dividend reinvestment plans on an income share (Telecom NZ stands out 
as a good example of this) are a very bad thing for the income 
investor.  By contrast if you are invested in a 'growth' share, then 
a dividend reinvestment scheme can be a good idea.

SNOOPY



---------------------------------
Message sent by Snoopy 
e-mail  tennyson@caverock.net.nz
on Pegasus Mail version 2.55
----------------------------------
"You can tell me I'm wrong twice, 
but that still only makes me wrong once."

----------------------------------------------------------------------------
To remove yourself from this list, please use the form at
http://www.sharechat.co.nz/chat/forum/