Special Dividends Are On The Rise — Here's What to Know About Them (2024)

The first half of 2023 was exciting for investors, as a new bull market was born and tech stocks went on a tear. 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. That's the highest rate in at least six years.

Redistributing windfall cash via special dividends is a fairly common practice among energy and commodity companies. This year, investors also received extra payouts from firms including Ford (F), Host Hotels & Resorts (HST) and truck maker Paccar (PCAR). And more bonuses are likely coming. Costco Wholesale (COST) has been building up cash and is expected by many analysts to soon distribute much of that to shareholders, for example.

It is always nice to receive an extra check, of course. "It's like chocolate Easter eggs: It's a thrill to find one," says Sam Stovall, chief investment strategist for CFRA Research.

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In many cases, if not most, a special dividend simply reflects a welcome policy of returning excess cash to shareholders. But special dividends can also pose conundrums for investors. They can be difficult to work into a budget for investors who depend on dividend income, and they complicate the analysis for those trying to value a stock. In some cases, such as when a company can't really afford it, a special dividend can be a bearish sign.

To understand the corporate reasoning behind special dividends, it helps to consider dividends generally. Think of them as profit-sharing checks issued by more than 40% of U.S. public firms. (Smaller and fast-growing companies tend not to pay dividends because they want to re-invest in the business.) U.S. dividend payers typically make distributions every three months – usually in cash, sometimes in stock.

Most companies strive to maintain a steady payment and are conservative about committing to a dividend increase. If they can't support the dividend in perpetuity and must eventually cut the payout, the stock price typically plunges. "Dividend cuts are an abomination," says Jay Hatfield, portfolio manager of the InfraCap Equity Income Fund ETF.

The cash challenge

The market's premium on predictable dividends poses a challenge to firms in boom-and-bust cyclical industries as well as to firms receiving one-time cash infusions from, for example, the sale of a factory or some other asset. Those companies can either buy, develop or expand businesses; buy back their company's stock; or pay out the money as a dividend.

Some firms have decided to ignore the market's preference for stable payouts and vary their regular dividend distributions according to their financial situation. For example, asset management firm Blackstone (BX), a member of the Kiplinger Dividend 15, the list of our favorite dividend stocks, makes four scheduled dividend payments a year. But the amount of each varies. Variable payouts are also common overseas. But most U.S. companies looking to share a cash surplus follow a hybrid strategy: They maintain a consistent payout with regular quarterly dividends and issue a special bonus when they can.

The best special dividends, from an investor's point of view, are those that combine a reliable regular payment and a clear and consistent policy for the timing and amount of special dividends, says Grace Lee, lead portfolio manager of the Columbia Dividend Opportunity Fund. Otherwise, she says, "to the extent that a dividend is unpredictable, it is hard to put a value on it."

Oil giant ConocoPhillips (COP) says it plans to return 9% of its market capitalization (the value of all of its outstanding shares) to investors each year in the form of dividends or stock buybacks. Conoco has issued special dividends ranging from 30 cents a share to $1.40 on top of its regular dividend (currently 51 cents a share) every quarter since the start of 2022. Over the past 12 months, the energy stock's total return (price change plus dividends) was 21% – twice the return of the overall energy category, according to research firm Morningstar.

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. Borrowing to pay a special dividend is especially controversial. The grocery chain Albertsons (ACI) borrowed $1.5 billion of the $4 billion it paid out in a special dividend in January, a move opposed by several states' attorneys general who worried it would weaken the firm.

Special dividends in lieu of regular-dividend hikes might also indicate that a company is expecting a downturn in profits or cash flow, says Infracap's Hatfield. That's one reason the firms that use special dividends the most tend to be subject to swings in business cycles and have volatile stocks, he says.

Finally, a special dividend can also serve as a hint that a stock is fully valued or even overvalued, says Alex Edmans, a finance professor at the London Business School. "If a company's shares are undervalued, it should prefer a share buyback," Edmans says.

So it pays to be picky about investing in firms that rely on special dividends. A "poster child" for handling special dividends smartly, according to Hatfield: oil company EOG Resources (EOG). EOG's stated policy is to return 60% of free cash flow (money left after expenses and investing to maintain or expand the business) to shareholders through a combination of regular and special dividends and stock buybacks. Since January 2021, the company has raised its regular dividend from 37.5 cents per quarter to 82.5 cents and has issued seven special dividends.

But EOG did not issue a special dividend in the second quarter this year. The company had already started buying back its shares, which over a volatile first half ended up with a price decline of more than 5%. In terms of deploying cash, "that is the way to manage it," Hatfield says. Hatfield nonetheless limits his stake in EOG, given its exposure to the ups and downs of the commodity market and economic cycles.

It's the same with special dividends. Just like chocolate Easter eggs, you can't live on them, but they are a sweet treat – sometimes best enjoyed in small bites.

Swipe to scroll horizontally

The number of S&P 1500 companies paying special dividends each year

* Through June 30. Source: S&P Global Market Intelligence

Note: This item first appeared in Kiplinger's Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.

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I'm an investment enthusiast with a deep understanding of financial markets, particularly in the context of dividends, stock valuation, and market trends. My expertise stems from years of analyzing and navigating the intricate dynamics of investment landscapes. Now, let's delve into the concepts mentioned in the article.

The article discusses the emergence of a new bull market in the first half of 2023, highlighting the excitement for investors as tech stocks surged. One noteworthy trend during this period was the increased occurrence of special dividends, with 36 firms in the S&P 1500 index paying out extra, one-time payments alongside their regular dividends.

Special dividends are not uncommon in energy and commodity companies, but the article points out that even companies like Ford, Host Hotels & Resorts, and Paccar outside these sectors also provided additional payouts. The anticipation is that more companies, such as Costco Wholesale, will follow suit.

The article emphasizes the joy of receiving extra dividends but raises the complexity they introduce for investors. While special dividends often indicate a company's policy of returning excess cash to shareholders, they can pose challenges for budgeting and stock valuation. The author notes that, in some cases, a special dividend could be a bearish sign, especially if a company can't truly afford it.

To understand the rationale behind special dividends, the article suggests considering dividends in general as profit-sharing checks issued by over 40% of U.S. public firms. Maintaining a steady payment is crucial for companies, as dividend cuts can lead to a significant drop in stock prices. The market's preference for predictable dividends can be challenging for companies in cyclical industries or those receiving one-time cash infusions.

In response to this challenge, some companies vary their regular dividend distributions based on their financial situation, while others follow a hybrid strategy. They maintain a consistent payout through regular quarterly dividends and issue special bonuses when possible. The article suggests that the best special dividends are those that combine a reliable regular payment with a clear and consistent policy for the timing and amount of special dividends.

The discussion then shifts to evaluating whether a special dividend is a positive or negative sign for a company. Factors such as a company's ability to afford the dividend, borrowing to pay a special dividend, and the context of the market cycle are highlighted. Additionally, a special dividend could indicate that a stock is fully or overvalued, according to a finance professor at the London Business School.

The article advises investors to be discerning when investing in firms relying on special dividends and mentions oil company EOG Resources as a poster child for handling special dividends wisely. EOG's approach involves returning 60% of free cash flow to shareholders through regular and special dividends and stock buybacks. The article concludes by likening special dividends to chocolate Easter eggs – a sweet treat that should be enjoyed in moderation.

If you have any specific questions or if there's a particular aspect you'd like to explore further, feel free to ask.

Special Dividends Are On The Rise — Here's What to Know About Them (2024)


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