Canadian Dividend Investors
1
DRIPs and DFCs
Dividend reinvestment plans (DRIPs) are not recommended
for anyone willing to manage their own retirement portfolio.
Bruce Smith
Meet some real DRIPS
Dividend reinvestment plans (DRIPs), offer the shareholder the option of receiving their annual dividends as additional common shares of the company, instead of a cash payment. The shares are sold at a price that is slightly lower than the prevailing market price. Most professional financial advisors encourage their clients to use DRIPS, if available, because cash dividends are automatically converted into company shares, thereby eliminating the need for clients to decide how to reinvest their shares. In addition, acquiring shares through a DRIP avoids trading and brokerage fees.
I agree that for those investors who have little or no interest in managing their investments, DRIPS are a useful option. However, in my opinion, for those investors who actively manage their investment portfolios, the disadvantages of DRIPs outweigh their advantages. In particular, the prevailing market price of the shares may be significantly higher than their fair share value, in which case you may be buying the shares when the price is near an historically high value. Secondly, even if the prevailing market price is lower than the fair share value, you may have other companies in your portfolio that can be purchased at an even greater discount to their fair share value, and possibly near an historically low price.
For anyone who is willing to take the time to monitor and manage their investments, it is preferable, in my opinion, to receive all your dividend payments as cash, which can be left to accumulate in your portfolio. When the market price of one or more of your favourite companies falls, such that the P/E ratio is near an historically low value, you can use your accumulated cash to buy additional shares.
You should discount DCF analyses
A number of financial experts have suggested that the fair share value (intrinsic value) of a company’s common shares can be determined using discounted cash flow (DCF) analysis. DCF analysis assumes that the financial value of a common share is equal to the total value of all the dividends expected to be paid per share into the indefinite future, discounted to the present value. (Present value is based on the fact that a dollar in your hands today is worth more than a dollar that will be paid to you ten years from now, because of the effects of monetary inflation.)
The fair share value calculated using discounted cash flow (DCF) analysis requires an estimate of two variables:
1) The annual dividend that will be paid per common share, every year into the indefinite future, and
2) The annual discount rate (the inflation rate) that should be applied to the dividend every year into the indefinite future.
Unfortunately, the fair share value calculated using DCF analysis is very sensitive to small changes in either of these two variables. As a result, the analysis can yield a wide range for the fair share value of the shares even when the estimated values of both variables are reasonable. As a consequence, the fair share values calculated by DCF analysis are not very useful for investors.