calculates the number of shares to which each participant is entitled and buys the shares on the stock market. Shares are then distributed to the participants.
The administrator will obtain the best price it can for the purchase and because the share purchases can be aggregated, the dealing costs tend to be relatively low.
The arguments for and against DRIPs are exactly the same as for scrip dividends. If you elect to take scrip dividends where possible you will almost certainly be keen to take advantage of DRIPs as well. DRIP shares issued into an ISA account remain within the ISA wrapper just as scrip dividends do.
A list of companies that have a DRIP scheme can be found on the Equiniti share registrars website at:
www.shareview.co.uk/Products/Pages/applyforadrip.aspx
Where companies offer neither a scrip dividend nor a DRIP, your stock broker may offer a dividend reinvestment scheme, automatically reinvesting the cash dividend into the relevant company’s shares. Again, the arguments for and against are the same as for scrip dividends and again any shares issued in this way remain part of an ISA.
Some brokers lump together dividends paid to several clients holding shares in the same company and buy new shares immediately. Others wait until cash builds up in each individual client’s account before buying. Aggregating cash in this way reduces dealing costs.
When you set up an online account you will be asked whether you want to have dividends remitted to your bank account or retained within the investment account. If you want your dividends to be reinvested automatically, check that this option is available, otherwise find another online broker.
If you are operating a traditional account with your broker, ask if this option is available.
Special dividends
Occasionally companies will pay a special dividend. This is a one-off payment in addition to the normal interim and final dividends but, unlike the regular payouts, it will not be repeated the following year.
A special dividend usually arises when a company has sold some assets for cash and has no obvious way of using that money to expand the business. Another possibility is that the company has retained large sums of cash from previous profits, possibly to finance a planned acquisition that never materialised, and has finally decided that there is no point in hanging on to the money.
One should not look a gift horse in the mouth and it is right that this money should be handed out to shareholders who do, after all, own the company and all its assets including cash.
A special dividend does imply that the company is on a sound financial footing and that regular dividends are secure for the foreseeable future, otherwise the company would shore up the balance sheet or keep the cash in reserve to maintain regular dividends.
On the other hand, if the company has sold assets its earnings may be reduced in future. Another negative view could be that if the company is returning cash to its shareholders then this suggests the directors are lacking in ideas of how to grow the company. You need to look at the circumstances and decide.
Whatever the reason for the special dividend, remember that it is a one-off payment and that dividends are likely to return to normal the following year.
Dividends declared in foreign currencies
Foreign-based companies and those with overseas operations may declare their results in a foreign currency, most likely US dollars or euros. This can make sense if most of their income and expenditure is priced in that currency.
Some UK companies present their results in dollars, particularly those in the oil industry or mining, where products are priced in the American currency.
European companies will normally declare their results in euros, although they may use pounds if their shares are listed in the UK. Otherwise the international currency is the US dollar.
The dividend will still be paid to you in pounds sterling but the amount will depend on the prevailing exchange rate. It follows that dividends from these companies tend to be more erratic as exchange rates fluctuate. When the value of the pound falls you do better; when the pound rises your income is reduced.
Another drawback is that foreign companies will operate within different political and legal systems. This is particularly relevant if you choose an overseas company with its shares quoted on AIM, where the regulatory framework is less rigorous.
Nevertheless, a willingness to invest in companies declaring their results in dollars or euros will widen your potential range of investments and spread your risk.
Key points
To be able to pay regular dividends a company must generate profits and cash.
Dividends are in effect paid out of what is left over after all other commitments have been met.
The dividend is decided by the board of directors, usually following the recommendation of the finance director.
Chapter 2. The Dividend Timetable
Payment frequency
Dividends are normally paid twice a year but they may be paid four times a year or, more rarely, once a year.
Frequency of payment is not particularly important in itself as long as the company maintains a regular pattern. If you want dividends to live on, then companies paying four times a year give you a smoother flow of income.
However, finding companies making steady, reliable profits is more important than looking for ones that make more frequent payouts.
Once-a-year dividend payments
This is extremely rare. A company making just one annual payment is probably very small and is trying to save money by reducing administrative costs. You should be more cautious of such a company as you will want to be satisfied that it has adequate financial resources.
Most dividend investors would prefer a steady stream of dividends throughout the year rather than have them lumped together, although having just one company that pays a single dividend in your portfolio should not be too much of a distortion overall.
One point to bear in mind is that other investors will be wary of such companies so they may be comparatively cheap to buy.
Twice-a-year dividend payments
This is the norm for the UK. One dividend, the interim dividend, is paid after the half-year results are announced. The second dividend, the final dividend, is paid after the full-year results are in.
Table 2.1 gives some examples of companies with financial years to the end of March 2011 paying two dividends a year.
Table 2.1– Sample dividend payments for UK companies
