Lately, I received an email from R, a Dividend Vault subscriber, as follows:
In brief, the question is: “Which of the two is a better choice for investment? Is it:
1. a stock that doesn’t issue more shares over time?
2. a REIT that issues more units over time?
This is assuming both the stock and the REIT are fundamentally solid.
To answer this, let us work out a few scenarios:
Scenario 1: Dividend Growth is Equal
Let’s say the stock and the REIT paid $50 million in dividends or income distribution in Year 1. In that year, both of them had 100 million shares or units in issue.
Thus, at Year 1, the stock’s dividends per share (DPS) was $0.50 and the REIT’s distribution per unit (DPU) was $0.50. Assuming that their valuations remain constant at 5% yield, therefore, the prices for both the stock and the REIT are $10 respectively.
Over the next 4 years, both the stock and the REIT have increased the dividends or distributions payments by 5% per year. The stock maintained its number of shares in that period. However, in the REIT’s case, its number of units had also increased by 5% per year.
Therefore:
The Stock – Dividend Growth: +5%; No. of Shares: +0%
If you invested in “the stock”, you would first receive more DPS in Year 2-5. Assuming that it had maintained its valuation at 5% yield constantly, you would enjoy a sustainable capital gain where the price of “the stock” increases from $ 10.00 in Year 1 to $ 12.16 in Year 5.
The REIT – Dividend Growth: +5%; No. of Shares: +5%
If you’d invested in “the REIT”, the amount of DPU you’ll receive would remain constant at $0.50 in Year 2-5. This is because the 5% dividend growth was effectively cancelled out by the 5% rise in its number of units. You won’t have any capital gains as its price remains at $10.00 a share.
Hence, when all are equal, the stock is a better investment than the REIT for the stock has “zero share dilution” in that period.
Scenario 2: REIT’s Distribution Grow Faster than Stock’s Dividends
But, with that being said, it is possible for “the REIT” to be a better investment than “the stock” in the five-year period despite the REIT having “share dilution”.
Consider this scenario.
Let’s say the REIT can grow its distribution, not by 5%, but by 15% per annum.
In this case, the amount of DPU you’ll earn would increase from $0.50 in Year 1 to $0.72 in Year 2. This works out to be a growth rate of 9.5% as its distribution growth rate was cancelled out by the “share dilution” in that period.
You’ll enjoy a higher capital gain as its price rose from $10.00 in Year 1 to $14.39 in Year 5.
The REIT – Dividend Growth: +15%; No. of Shares: +5%
Thus, as long as the REIT’s growth in DPU exceeds the stock’s DPS growth, the REIT would be a better investment despite it having “share dilution” in that period.
Scenario 3: Changes in Market Valuation
Back to Scenario 1.
We concluded that it is better to invest in “the stock” as it is zero share dilution, assuming that all is equal, especially market valuation remaining constant at 5% yield in that period.
Now, what if in Year 5, “the stock” was valued at 6% in dividend yields, instead of 5%, resulting from lower market demand for its shares?
The Stock – Dividend Growth: +5%; No. of Shares: +0%
Also, what if in Year 5, “the REIT” was valued at 4% in distribution yield, instead of 5%, resulting from higher market demand for its shares?
The REIT – Dividend Growth: +5%; No. of Shares: +5%
Thanks to this, the one who had invested in “the stock” has close to zero capital gains in Year 5. Meanwhile, the one who’d invested in “the REIT” enjoys a capital gain in Year 5 despite it having share dilution.
Scenario 4: Share Buybacks
Let’s work out a final scenario.
Here, we assume that both the stock and the REIT have:
1. 5% growth in dividends / distributions.
2. Valuation remains constant at 5% yield.
But this time, the stock exercises “share buybacks” regularly over the five-year period. For every year, the stock shall reduce its number of shares by 5%.
If you invested in “this stock”, you would first receive even more DPS in Year 2-5. Assuming that it had maintained its valuation at 5% yield constantly, you would enjoy even more capital gain for this stock, where its price increases from $10.00 in Year 1 to $14.92 in Year 5.
The Stock – Dividend Growth: +5%; No. of Shares: -5%
Conclusion: Factors to Consider
All in all, from these simple exercises, we learnt that there are many factors, which can impact a stock’s total returns. Once again, these factors include:
1. Amount of dividends / income distributions
2. Number of shares / units (share concentration / dilution)
3. Valuation
When all factors and variables are equal, the stock or REIT, which practices continuously “share buybacks” or “no share dilution” shall be a better choice than others that dilute shares. But as an investor, I’ll consider and look at all the factors above before investing as it is more holistic.
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