Special Dividends on the Rise What to Know
Special Dividends on the Rise What to Know
Special Dividends: A Sweet Treat for Investors
The first half of 2023 brought excitement for investors, with a new bull market driving tech stocks to new heights. But it wasn’t just the usual suspects making waves. Surprisingly, even supposedly staid dividends got a little spicier, as 36 firms in the broad-market S&P 1500 index paid out special dividends – extra, one-time payments on top of their regular dividend payouts – from January through June, according to S&P Global Market Intelligence. This surge represents the highest rate in at least six years.
Redistributing windfall cash via special dividends is a fairly common practice among energy and commodity companies. However, this year, investors also received extra payouts from unexpected players like Ford (F), Host Hotels & Resorts (HST), and truck maker Paccar (PCAR). And there’s more in store. Costco Wholesale (COST) has been accumulating cash and is widely expected by analysts to soon distribute a significant portion of it to shareholders.
“It’s like chocolate Easter eggs: It’s a thrill to find one,” says Sam Stovall, chief investment strategist for CFRA Research. Receiving an extra check is always a pleasant surprise, but special dividends can pose conundrums for investors. They can be challenging to incorporate into a budget, especially for those who depend on dividend income. Additionally, they complicate the analysis for those trying to value a stock. In some cases, a special dividend can be a bearish sign if a company can’t really afford it.
To understand the corporate reasoning behind special dividends, it helps to consider dividends generally. Think of them as profit-sharing checks issued by over 40% of US public firms. While smaller and fast-growing companies tend not to pay dividends as they prefer to reinvest in the business, most US dividend payers make distributions every three months – usually in cash, sometimes in stock.
Companies typically strive to maintain a steady payment and are conservative about committing to a dividend increase. If they struggle to support the dividend in perpetuity and eventually have to cut the payout, the stock price typically plummets. Therefore, dividend cuts are viewed as an abomination, according to Jay Hatfield, portfolio manager of the InfraCap Equity Income Fund ETF.
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The Cash Challenge
The market’s preference for predictable dividends poses a challenge for firms in boom-and-bust cyclical industries as well as firms receiving one-time cash infusions from the sale of assets or other sources. These companies have options: they can buy, develop, or expand businesses; buy back their company’s stock; or pay out the money as a dividend.
Some firms have chosen to ignore the market’s demand for stable payouts and vary their regular dividend distributions based on their financial situation. For instance, asset management firm Blackstone (BX) makes four scheduled dividend payments a year, but each varies in amount. Variable payouts are also common overseas. However, most US companies with a cash surplus tend to follow a hybrid strategy: maintaining a consistent payout with regular dividends while also issuing special bonuses when possible.
According to Grace Lee, lead portfolio manager of the Columbia Dividend Opportunity Fund, the best special dividends are those that offer a reliable regular payment and a clear and consistent policy for the timing and amount of special dividends. Otherwise, an unpredictable dividend is difficult to evaluate for its value.
Oil giant ConocoPhillips (COP) plans to return 9% of its market capitalization to investors each year in the form of dividends or stock buybacks. Since the beginning of 2022, Conoco has consistently issued quarterly special dividends ranging from 30 cents to $1.40 on top of its regular dividend of 51 cents per share. Over the past 12 months, the energy stock has delivered a total return (price change plus dividends) of 21% – twice the return of the overall energy category.
Is a Special Dividend Good or Bad?
“Not all special dividends are created equal,” says Steve Sosnick, chief strategist at Interactive Brokers. Some firms struggle to pay dividends they can ill afford, making borrowing to pay a special dividend a controversial move. The example of grocery chain Albertsons (ACI) borrowing $1.5 billion to fund its $4 billion special dividend in January drew opposition from several states’ attorneys general concerned about weakening the firm.
Furthermore, special dividends in lieu of regular dividend hikes might indicate that a company is anticipating a downturn in profits or cash flow, according to Infracap’s Hatfield. This tendency is particularly observed in firms subject to swings in business cycles and volatile stocks.
Lastly, a special dividend can also hint that a stock is fully valued or even overvalued, as suggested by Alex Edmans, a finance professor at the London Business School. Undervalued companies, on the other hand, are more likely to prefer a share buyback.
Considering these factors, it’s essential to be selective when investing in firms that rely on special dividends. A “poster child” for handling special dividends smartly, according to Hatfield, is oil company EOG Resources (EOG). EOG’s policy is to return 60% of free cash flow to shareholders through regular and special dividends and stock buybacks. They have consistently maintained this policy while raising their regular dividend and periodically issuing special dividends.
However, it’s prudent to limit exposure to EOG due to its ties to the commodity market and economic cycles. Special dividends are similar to chocolate Easter eggs – they bring delight but cannot fully satisfy our financial needs. They are best enjoyed in moderation.
*Through June 30. Source: S&P Global Market Intelligence
This article was originally featured in ANBLE’s Personal Finance Magazine, a monthly trustworthy source of advice and guidance. Subscribe here to access more valuable financial insights and tips.
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