Our DRP heroes

A detailed analysis of Australian dividend reinvestment plans (DRPs) by Eureka Report has found that investors in the companies with the most active DRP programs generally have been better off taking new shares over cash dividends.

Our findings show that the 15 companies in the ASX50 index that have had a DRP operating consistently for 10 years or more have outperformed the broader market over time.

Over the last five years this group of 15 stocks has outperformed the ASX50 by 14.8% and the ASX200 by 19.6%. In other words, given the option of taking the money or not, those investors that chose to reinvest their payouts in these companies’ shares were better off than those who didn’t.

Out of the list, the best performers over a 10-year period include Commonwealth Bank (CBA), Woolworths (WOW), and Origin Energy (ORG). See the full list below.

On face value then, DRPs would seem to the best option for investors. But before you tick that DRP box, you also need to consider that investors in some schemes have actually been worse off over time. When it comes to DRPs, it’s definitely a case of doing your homework. And a lot of this comes down to why certain companies are offering dividend reinvestment plans in the first place. Put simply, for some companies it’s more about helping themselves than their shareholders.

Performance of companies with consistent DRPs

Some companies turn their DRP on and off, only offering the plan when they need capital, or can’t afford to pay the full dividend in cash  

Out of the ASX50 there are currently 28 companies with active plans, and 15 who have had it in place constantly for 10 years or more, and have paid dividends every year.

We compared the returns of these 15 companies to both the ASX50 and ASX200 indices, assuming all gross dividends were reinvested back into the companies at market price.

The returns are not a precise reflection of DRP participation due to two factors. One, we haven’t allowed for the discount that often occurs as part of the program. Two, sometimes DRP plans are capped. As a result, it is not always possible to receive the full amount of the dividend in new stock.

Positive results, but no guarantees

The companies with consistent DRPs have outperformed the ASX50 and ASX200 over a range of timeframes. The 222% average return of the 15 reinvested companies compares to the ASX50 10-year return of 192% (assuming reinvestment of gross dividends).

DRPs aside, there is also a positive compounding effect in taking additional shares in robust companies through the cycle versus not reinvesting the dividends. This can be seen from the average 10-year reinvested return of 222% vs the ASX50 10-year return of 61% achieved without reinvesting dividends. If we assume an average annual yield of 4%, which has been achieved every year for a decade, the allocation of the accumulated dividends would play an important part in this comparison.

While this analysis shows that a company that consistently employs a DRP is likely to outperform, there is no guarantee that past results will be replicated moving forward. There are also no guarantees that the companies who have consistently employed a DRP will maintain the offer in future.

Another factor to consider is that through the more difficult GFC years, there was a large increase in the amount of companies offering DRPs. This was due to the constrained balance sheets and lack of alternate funding options. Currently, with balance sheets generally in good shape, the amount of DRPs may be on the decline, and discounted offers are unlikely to be as common.

Understanding DRPs

DRPs remain common and popular among companies and investors – currently there are approximately 200 ASX listed companies with an active program.

They enable shareholders the option to take a portion, or their entire dividend, in the form of additional shares rather than cash with no brokerage fees, and sometimes at a discounted price.  

The motivations for companies to offer a DRP are varied – ranging from a service to shareholders, to the program being a capital management tool that gives the company the ability to reduce their cash payout requirements for dividends.

As an investor, the decision to either reinvest dividends back into the company or receive a dividend cheque needs to be made in context of personal circumstances and if the stock remains undervalued.

As a general rule the questions that need to be asked are:

1. Why does the company have a DRP in place?
2. What are the specifics of the offer?
3. Is the company undervalued, and do I want to own more of this stock?

A company with a steady flow of increasing dividends is generally perceived by the market as healthy, and a company that is constantly issuing more capital is viewed negatively due to the dilutive effects for existing shareholders. The catch is some companies announce growing dividends without actually having the free cash flow to pay them out. With this in mind, when assessing why the company has a DRP, it is first critical to define the different types of plans.

Underwritten DRP – This basically allocates shares to a third party for any shareholder who chooses to accept the dividend rather than reinvesting it. It is a hidden capital raising and may be a red flag that the company will have ongoing cash flow issues. It is the least desirable form of DRP for a shareholder, and generally speaking these stocks should be avoided. Whilst the reasons for cash may be valid, it would be better for the company to either reduce or suspend its dividend.

Discounted DRP – When a company is trying to increase the participation the offer price will be at a discount – generally to the 5-10 day average price prior to the record date.

Shareholder Friendly DRP - Other than a discount, there is another major factor of the plan that when employed is a positive for shareholders – That is the company buying back shares on market and transferring them to the DRP participants. The offset is a clear indication that the DRP is in place as a service for shareholders, with no side-effects of shareholder dilution. It needs to be highlighted that the terms of the DRP can be frequently changed – hence just because a shareholder friendly form of the DRP is in place doesn’t mean it won’t be used as a capital raising tool in future periods.

Biggest Advantages/Disadvantages of constant DRP participation

• Positive: Assuming an appropriate selection of stocks, continual re-investment is going to compound returns with benefits increasing the longer the investment timeframe.
• Negative: Other than losing the focus of timing when a stock should be bought, the most common reason given not to consistently participate in DRPs is the extra record keeping – that is, each DRP has to be treated individually in regards to capital gains tax when the stock is sold.

The DRP sinners

Expanding the analysis to all of the companies with a current DRP in place, we have listed below the worst performers when again analysing the returns with gross dividends reinvested.

A scan of the list shows that none of the worst performers qualified for our earlier criteria of a consistent DRP and paying a dividend every year. Instead the companies below have turned the DRP on when they needed to raising additional capital and/or because they didn’t have the cash to pay out dividends.

S&P500 dividend outperformers

Our work follows another study from “www.bankrate.com” demonstrating how important dividend returns have been in the US, especially for retirees. This analysis tested the returns of the S&P 500 Dividend Aristocrats – that is the 50-plus members of the S&P 500 that have not only paid dividends for the past 25 years but also increased them every year. Bankrate.com found that a 60/40 equity/bond portfolio of $1 million with the shares portion made up completely of Aristocrat stocks beat five other common allocations over the past 14 and 20 years.

As an example of the Aristocrat allocation, taking into account living expenses, someone who retired in 2000 with $1 million would today have nearly an additional $1 million when compared with someone who had invested in the S&P 500.

Summary

While there are pros and cons for participating in dividend reinvestment plans, our analysis suggests merit in participating in DRPs across the cycle for the large capitalisation stocks that consistently offer the plan.

Having said this, additional benefits can be gained from assessing the details of each plan and determining if the stock remains an attractive investment at the time of each DRP decision. This, however, is a lengthy process that doesn’t suit everyone.

Our conclusion, similar to the study by “bankrate.com”, is that the compounding effect of reinvesting dividends in strong companies will remain very beneficial for long-term investors.