When most investors hear about dividends they immediately assume a regular dividend paid by companies quarterly, or an interim dividend paid every six months. However, there are other types of dividends, including a special dividend. But what is a special dividend? And what is the difference between a special dividend and a regular dividend?
We have all the answers to these questions and more in this article.
What is a special dividend?
A special dividend happens when a company decides to distribute part of its profits, but in this case, the distribution is larger than the regular quarterly dividend. It is a one-time payment to shareholders as opposed to regular quarterly dividends.
Special dividends are usually paid on special events or occasions, and oftentimes it is a result of the company spinning off a subsidiary or selling it. Special dividends are also common when the company releases strong financial results, from either its core operations or from selling the company’s assets.
A special dividend is typically considered to be an extraordinary event by financial analysts, and it can have a significant positive impact on the stock price. As investors will buy the stock before the ex-dividend date, so they can receive the special dividend.
Special dividend vs regular dividend
There are a few main differences between special dividends and regular dividends:
They are paid sporadically, and most companies will rarely do it. By contrast, regular quarterly dividends are paid each quarter.
While regular dividends are paid on a quarterly basis, special dividends are only paid after certain events. Usually, the company receives a lot of cash from an asset sale or has strong financial results, and rewards shareholders.
Regular dividends tend to be a fixed percentage of the company’s earnings, and in most cases are a lot smaller than special dividends. It will often be larger than the quarterly dividend, and it can be a significant yield, compared with the current stock price, or market cap of the company.
Reasons why companies pay a special dividend
Here are some of the reasons why companies pay special dividends:
- Selling or spinning off a subsidiary
- Conservative dividend policy
- Strong earnings results
- Rewarding long-term investors
- Accumulated cash on the balance sheet
Selling or spinning off a subsidiary
One of the common reasons for a special dividend is when a company sells one of its subsidiaries. In this case, it uses part of the total amount of the proceeds to distribute among its shareholders.
It can also be paid following a spin-off. If the company was able to generate a sizable return through the spin-off process it might choose to distribute some of that capital back to shareholders.
Conservative dividend policy
There are also some companies that prefer to be conservative in their regular dividends. This means that they would rather pay a large special dividend than raise the quarterly dividend, and then be forced to cut it if the company’s financial performance does not remain the same.
When they present good yearly or quarterly results, they increase the distribution to shareholders with a special dividend. Perhaps the company is in a cyclical sector, and during the peak of the cycle, they prefer to distribute part of the profits.
They are also a great way of rewarding shareholders, without the commitment of having to pay the same dividend regularly.
On the other hand, if the company increased the regular dividend, by the same amount as the special dividend, some investors holding the stock could sell it if the dividend happens to be reduced.
Rewarding long-term investors
Special dividends are also a great way of rewarding long-term shareholders. Some stocks are favorites among long-term investors, especially dividend investors. Companies are well aware of this, and they use it as a way of rewarding those investors.
Investors that have a long-term investment horizon, might be more tempted to hold a stock that paid a special dividend in the hopes that it might happen again in the future.
The management in some companies is extremely efficient when it comes to allocating capital. For them to have unused capital, could make investors change the perception of their efficiency as allocators.
For this reason, they would rather allocate those funds to a special distribution, than have the money lay around indefinitely.
Strong earnings results
Another reason that could justify the payment of a special dividend is a strong financial performance. If for some reason the company had stellar results in the recent past, management might try to reward shareholders by distributing some of those profits.
Accumulated cash on the balance sheet
If the company accumulates a lot of cash on the balance sheet, and it does not have any way to reinvest that capital one of the options is sometimes to pay a special dividend.
As the capital accumulates, shareholders might wonder what the company intends to do with the money, and they can be highly critical of the management if they see that the company is just accumulating cash.
If this is the case there could be some signs that the expected growth for the company is low.
What can special dividends signal for investors?
Although special distributions are usually seen as a strong sign that the company is in good financial shape, they can also serve as a red flag to other investors that are not so concerned with dividends.
Here is what it could be signaling:
- Inability to reinvest capital at high rates of return
- Modest growth ahead
- Management is not making the most tax efficient decision
Inability to reinvest capital at high rates of return
One of the most evident conclusions investors might be able to make is that the company is not able to reinvest the money elsewhere. When a company is able to reinvest its capital at high rates of return it makes a lot more sense to invest the capital than to distribute it to shareholders.
Companies that usually pay special dividends, do not seem to be able to allocate that capital in the most efficient way, or they are too large to continue to grow at a fast pace.
The company could choose to reinvest within their core business or a new segment or even make an acquisition. If the company is not able to invest in other areas or make an acquisition that could also signal a lack of investment opportunities.
However, this is not always the case. Some companies and management teams will prioritize returning cash to shareholders in the form of dividends.
This is always dependent on the specific company, and it requires investors to analyze, and research this in more detail.
Modest growth ahead
For some investors, a special dividend could signal a lack of future growth opportunities. Since the company is not reinvesting the capital, it could mean that the growth might be modest in the next few years.
Management is not making the most tax efficient decision
Dividends in general are a tax-inefficient way of creating shareholder value. Although many investors love dividend stocks, every time the company distributes its profits, investors are forced to pay taxes.
To a certain extent, a buyback or investing that capital into expanding the business or an acquisition makes more sense from a taxation standpoint. For that reason, a special dividend could be a signal to shareholders that a company is not being the most tax efficient possible.
Is a special dividend good?
A special dividend is a strong sign that the company is in great financial shape, otherwise, it would not be able to distribute cash to shareholders. The stock price usually tends to increase following the announcement, as investors and traders try to pile in until the ex-date.
Depending on the amount of the special dividend it can be common for some stocks to decline after the ex-date since the cash that was once on the balance sheet was now distributed to shareholders.
Additionally, some investors question the distribution of dividends and especially special distributions. The reason is that the taxes paid by investors for receiving dividends are lost. This is why some companies such as Berkshire Hathaway do not pay dividends. Instead, they invest in the business or pursue acquisitions to create more shareholder value, while avoiding dividends on taxes.
Why do companies pay special dividends instead of raising the regular dividend?
Since raising quarterly dividends paid by the company could put pressure on the company to maintain their dividend at high levels, companies often choose to reward shareholders with a one-time dividend.
Since most of the time the special dividend is paid following an unexpected event like an asset sale or a better than expected financial year, it is better to pay a one-time dividend than to raise their regular dividend, which might have to be cut later on.
How do special dividends affect the stock price?
Special dividends tend to have a very positive impact on the stock price. When it is announced stocks tend to rally and usually make new highs. This is because investors will buy the stock just to receive the special dividend, and traders knowing this also tend to follow this bullish trade in anticipation of investors buying.
The stock price spike can, however, be short-lived, until the dividend ex-date. If the dividend is a large percentage of the market cap, and it is essentially not on the balance sheet anymore, it is expected that the stock valuation adjust accordingly. So after the payment, stocks tend to move slightly lower.
How do you qualify for a special dividend?
Every shareholder that owns the stock until the dividend ex-date will be entitled to receive the special dividend.
How do you calculate a special dividend per share?
When a company announces a special dividend it might announce a per share figure or the total amount that will be distributed among shareholders. To calculate the special dividend per share, you just the total amount the company will pay by the shares outstanding.
Special dividend per share = Total special dividend/shares outstanding
Special dividends are certainly a rare occasion, and they can great news for most dividend investors. However, it is important to analyze each company individually and understand why the dividend is being paid.
For dividend investors looking for stocks that pay special distributions to invest in for the long term can be a way of boosting your returns, and the passive income generated by your investment portfolio.