Dividend Reinvestment Plans
Many UK companies offer shareholders to reinvest their cash dividend payment automatically to buy new shares. These events are generally called Dividend Reinvestment Plans (abbreviated to DRIPs). Often PEP / ISA equity holders do not receive this option, although it is the Plan Managers decision whether or not they offer optional dividends. The options are simple – cash or stock. In the UK the default instruction (i.e. what shareholders receive if they make no election) is cash. With DRIPs the reinvestment price is not calculated until after the pay date of the dividend. This is because the company will actually be distributing shares at a discount (sometimes) to market value on pay date. Shareholders till have to pay tax on the income (dividend) as normal.
This benefits the shareholder as it allows the investment return from dividends to be immediately invested for the purpose of price appreciation and compounding, without incurring brokerage fees or waiting to accumulate enough cash for a full share of stock. Some DRIPs are free of charge for participants while others do charge fees and/or proportional commissions. Always read the terms.
Optional Stock Dividend / SCRIP
Like DRIPs, This is an issue of new shares to existing shareholders on a pro-rata to their current shareholding at no cost, calculated based on the company’s previous financial period, i.e. its dividend / income payment.
In some markets the optional dividend ratio, i.e. the number of new shares to be received based on ex-date holding, is announced before the shareholders instruction deadline. This allows the shareholder to make a more informed decision, although of course sudden fluctuations in the market after the deadline to instruct, and before the pay date, may mean a relative financial loss is made.
Some companies will offer a premium rate (enhanced optional dividend) for shareholders to elect to take the stock. This is because the company is wanting to retain its cash flow and issue shares instead, so provides an incentive. New shares are issued to the value of the net dividend (after the tax rate has been deducted).
It is also worth noting that some markets issue a stock default (generally Dutch, South African and sometimes Hong Kong) meaning that shareholders who fail to elect cash will receive shares. However, sometimes custodian banks will apply their own default in these cases, but be warned. Always check the terms, especially on the Dutch ones.
Often when a company is listed on several different stock exchanges, it offers shareholders the option to recieve the cash dividend in an option of their choice. FOr example, HSBC often offer a reinvestment / stock option, plus income in GBP, USD or HKD. The same applies to many Canadian companies that are also listed on the US exchanges, i.e. CAD or USD.