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DRIPs 101: DRIP Classifications

Robert Gibb

Persons just entering the world of dividend reinvestment planning are sometimes confused in their understanding of what a DRIP really is. There are a few reasons for this fact:

There are six different types of DRIPs.

Active DRIPpers use the term DRIP incorrectly.

Depending on whom you talk to, the term DRIP means different things to different people.

It is important to be aware of the differences in the six DRIP types to avoid errors and frustration.

The six different types can be subdivided into true DRIPs (pure DRIPs and DRIPs plus SPPs) and DRIP mimics (synthetic DRIPs, psuedo DRIPs, Direct Stock Purchase Plans and American Depositary Receipts). Mimics, while not true DRIPs, offer features that approximate their advantages, such as low or no broker fees, low minimum investment requirements and dividend reinvestment. Following is a brief description of the differences among the various DRIP types.

Pure DRIPs

This is simply a dividend reinvestment plan or DRIP. This is a company-sponsored plan. If you held a company that offered a pure DRIP in a broker account you could ask to have shares removed from your account and delivered into your hands. When shares are held with a broker it is referred to as "street name". You could then register in the company’s DRIP and have none, some, or all of your dividends reinvested in further shares, whole and partial, at little or no cost, depending on the individual plan particulars. For example, if you receive $50 in dividends and the current share price is $20 you will receive 2.5 new shares. Examples of Canadian companies offering this type of DRIP are: Magna (TSX:MG.A), Thomson Corp. (TSX:TOC) and TD Bank (TSX:TD).

DRIPs plus SPPs (OCPs)

Some dividend reinvestment plans offer a feature called a Stock Purchase Plan (SPP). This allows shareholders registered in the company DRIP to purchase further shares directly from the company, often in low dollar amounts while avoiding or reducing brokerage fees. SPPs in the United States are referred to as Optional Cash Plans (OCPs).

This is one source of confusion. The vast majority of persons who say they DRIP are actually referring to a DRIP plus SPP. DRIPpers use the term incorrectly. However, it is more fun to say, "I DRIP." The best acronym that I have come across for this type of plan is TransAlta’s (TSX:TA) DRASP or dividend reinvestment and stock purchase plan.

The DRIP plus SPP is the plan most important to readers of this column. The "DRIPs and SPPs" feature listed in the index of this magazine indicates which Canadian companies offer this type of plan.

Synthetic DRIPs

This is not a true DRIP. Rather it is a feature offered to broker’s clients that mimic pure DRIPs. In this plan any dividends received can be reinvested in further shares. One major difference from a pure DRIP is that virtually all Canadian brokers will buy only whole shares with the dividends. Using the example from above, in a synthetic DRIP, if you receive $50 in dividends and the current share price is $20, you will receive 2.0 new whole shares and $10 cash in your account.

In a synthetic DRIP the only way to make optional purchases is to pay the brokerage commission. Another potential drawback is that the brokerage usually requires all securities in the account be registered in the synthetic DRIP. The client cannot selectively decide which securities are enrolled. It’s all or nothing.

The synthetic DRIP can be a source of confusion to the uninitiated. I have often talked with people who were interested in DRIPs, asked their broker about them and were told the brokerage house offered them. Naively, the clients leave it at that. What the client is referring to is a DRIP plus SPP. The broker is talking about something completely different.

Pseudo DRIPs

Currently I am not aware of any true pseudo DRIPs in Canada. Commissions are so low that they can be used to invest small dollar amounts in the manner of a DRIP. Americans use pseudo DRIPs to offset fees in high cost U.S. plans or to purchase companies, in small dollar amounts, that do not offer DRIPs.

The best known U.S. pseudo DRIPs sources is ShareBuilder. As a third party broker, this pseudo DRIP is not open to Canadians.

Direct Stock Plans (DSPs)

It is possible to avoid a broker completely and open an account with a company through a Direct Stock Plan (DSP). Approximately 700 U.S. companies offer DSPs. All DSPs become DRIPs plus SPPs (OCPs) once an account is opened. The downside of DSPs is that most come with fees. The best source of information on U.S. DSPs is NetStock Direct (http://www3.netstockdirect.com).

Not long ago the Ontario Securities Commission enacted a rule allowing for DSPs in Canada. However, as the BC and Alberta Commissions have not adopted this rule, there are no Canadian companies offering DSPs at this time.

American Depositary Receipts (ADRs)

Not true DRIPs, American Depositary Receipts (ADRs) represent ownership in companies outside Canada and the United States. ADRs trade on the New York Stock Exchange.

Essentially, a bank will purchase shares of a foreign company on its home exchange and deposit the shares in a local custodian bank. The bank then sells "receipts" representing proportional ownership in these shares. As the fees for optional purchases range from US$2.50-$5.00, ADRs mimic the medium and high fee U.S. DRIPs.

ADRs can be purchased directly through Citibank and the Bank of New York (http://www.adrbny.com/ ).

Thank you for the many telephone calls and the positive feedback. If I haven’t responded, it is usually because my answering machine has cut you off mid-message.

Robert Gibb, 106-1217 Pandora Avenue, Victoria, BC, V8V 3R3 (250) 383-7075 [email protected]. He gives seminars on dividend reinvestment plans. Robert is a frequent contributor to Internet DRIP boards under the nickname OperaBob.

© Canadian MoneySaver, PO Box 370, Bath, ON K0H 1G0 613-352-7448 - Published May 2003