The Dark Side of Special Dividends

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Ordinarily, a company's decision to pay a dividend marks a sign of health and prosperity for investors. In that light, the recent flood of special dividends has made many shareholders feel like Christmas has come early.

But amid all the glee over getting a big payout right before higher tax rates take effect that could make dividends look a lot less attractive for many investors in 2013, there's a more worrisome aspect concerning all this money going back to shareholders. As you see your dividend payment come into your brokerage account, the question you should be asking yourself is this: Was a special dividend really the best thing this company could come up with to spend its money?

The special dividend craze
As 2012 draws to a close, there's definitely no shortage of companies declaring special dividends. Fool contributor Demitrios Kalogeropoulos counted 170 special dividends declared in November, and unless the fiscal cliff gets resolved unexpectedly quickly, you can expect to see more come this month as well.

Moreover, the amounts getting paid out are truly huge in some cases. Las Vegas Sands (NYSE: LVS  ) gave investors a $2.75-per-share bonus, representing almost 6% of its current share price.Costco's  (NASDAQ: COST  ) $7-per-share dividend gives shareholders back about 7% of what shares fetch, while Sturm Ruger (NYSE: RGR  ) is handing out almost 8% of its stock price with its $4.50-per-share special dividend.

Theoretically, a special dividend should have absolutely no effect on a stock's price. After all, it's not as if companies create their dividends out of thin air; the money that they're paying out in dividends is money they won't have to spend on new and existing projects, buyouts, share buybacks, or other corporate purposes. Yet in most cases, investors have pushed share prices up dramatically following the special dividend announcement.

What, me worry?
The combination of companies being willing to part with so much of their cash along with investors rewarding them for doing so marks an interesting shift in investor philosophy. In the past, investors preferred to see companies make productive investments with their capital, finding ways to earn profits that exceeded what shareholders could get from alternative investments of their own. Now, though, companies are being rewarded with higher stock prices when they choose not to pursue internal investment opportunities and instead just hand back cash to shareholders.

That raises two important questions. Are companies really so unwilling to invest in their own businesses that they've given up and are making special dividends as a way of punting on capital allocation decisions? And conversely, are investors really so scared of companies making bad investments that they're willing to reward them just to get their money back?

Throughout the recession and the slow economic recovery since, many have believed the answer to the first question is yes. Look at the banking sector, for instance, and you'll find at least some reluctance for banks to return to their core business of making loans.

And as for the second question, if the answer is yes, you can't really blame investors for feeling that way. Wastes of shareholder capital are countless, with Hewlett-Packard's (NYSE: HPQ  ) recent debacle with Autonomy and Microsoft's (NASDAQ: MSFT  ) big writedown from its buyout of aQuantive ranking among the worst but by no means the only massive bad capital allocation decisions from major corporations.

Take the money and run
Of course, companies are being careful not to suggest that they're doing anything that could hamper their ability to take advantage of future business opportunities. For instance, in Sturm Ruger's announcement, CEO Michael Fifer said that its payout "reflects our confidence in the future to be able to pursue good opportunities that come our way." Costco similarly pointed to its "strong balance sheet" as a prime component in making the payout possible.

With bond markets as friendly to corporate borrowing as they've ever been, paying a big dividend is no guarantee against an impulse buy gone wrong. But at the very least, every dollar you get from a stock in a special dividend is a dollar that the company's management team can't waste. That cynical viewpoint may be a dark cloud over the investment world, but when you think about it, maybe that's really the most special thing about all these special dividends we've seen.

Despite its special dividend, Las Vegas Sands certainly isn't afraid of big bets. After big successes in Macau, the company is now looking to spread its empire further. But is Las Vegas Sands a buy here, or will it prove unable to replicate its hugely profitable past experience? Find out in our popular premium report on Las Vegas Sands. We're providing a full year of analyst updates to go with it, so make sure to claim your copy today by clicking here.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.

Read/Post Comments (24) | Recommend This Article (24)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 03, 2012, at 11:18 AM, loufarr wrote:

    In the case of LVS, 51% owned by CEO, Treasurer Sheldon Ableson, declaring the $2.75 share dividend yields 1.4 billion + the regular dividend of 400+ million. Then, he and his wife, who owns approximately 200 million shares will save some dividend tax dollars this year of approximately 100 million + dollars, if the dividend tax is hiked. Is this any way to run a gambling empire? -- What do we know? We're just some poor schnooks trying to ride on his coat tails.

  • Report this Comment On December 03, 2012, at 11:28 AM, ninjah wrote:

    I like your article. But I do have a question about the meaning of your sentence "And conversely, are investors really so scared of companies making bad investments that they're willing to reward them just to get their money back?" How are investors rewarding companies to get their money back? Bidding up the stock price? Am I missing something here. Thanks for any response.

  • Report this Comment On December 03, 2012, at 12:30 PM, stuckinamobile wrote:

    Leave it to the manipulating Fools to find something negative about dividends. I never met a dividend I did not like. The only obvols conclusion is that Cramer and all the misleading analysts in on the price fixing, must not be holding these stocks or not getthing kickbacks for promoting them.

  • Report this Comment On December 03, 2012, at 12:44 PM, BMFPitt wrote:

    I would rather Costco spend some of that money and build a store closer to me.

    But other than that I'm fine with it.

  • Report this Comment On December 03, 2012, at 1:07 PM, spokanimal wrote:

    Special Dividends are Symptomatic of the destruction wrought by Socialism.

    Simply put, President Obama has been threatening for years to punish capitalism with high taxes on those who provide and deploy investment capital into the U.S. The special dividends are simply a final, low-tax distribution to shareholders before the dark ages of U.S. investment sets in...

    ... probably accompanied by low growth, high un-employment, and minimal capital investment that is so characteristic of the countries that have followed the path of socialism and wealth re-distribution before us.

    We saw just the opposite in 1997, as Bill Clinton worked with the new, GOP dominated congress to lower capital gains taxes and unleash a torrent of tax revenues that grew the economy, minimized unemployment and balanced the budget. Obama's anti-capitalism crusade of punishing the sources of those same revenue streams should be expected to produce the exact opposite result.

    As for the special dividends themselves, under better presidential leadership, the companies paying these dividends might be expected to RETAIN those earnings and invest them into new american industry and more american jobs. I would contend that it isn't just getting under the wire on the 15% dividend tax that's driving the torrent of special dividends... but also the fact that many american companies simply don't see growth opportunities in the U.S. over the next 4 years, so they may as well return the money to shareholders to ship offshore or dive into bonds and gold.

    Socialism is a harsh lesson for countries to learn about in this way... but few american citizens truly understand what they're doing when a 20-something votes for Obama because he saw him on TV with Justin Bieber...

    ... Mr. Obama was highly reliant on such voters to NOT have an understanding of what his main supporters... Hugo Chavez and Raul Castro... had done to their countries before Mr. Obama set his sites on doing likewise to ours.


  • Report this Comment On December 03, 2012, at 2:41 PM, lkh1006 wrote:

    Given's COSTCO's unusual loyalty toward

    the economic plight of it's workers and it's customers, perhaps they are just being generous and sharing the wealth that they have among

    those who helped them get it.

    Corporate generousity could use more members, not more cynicism

  • Report this Comment On December 03, 2012, at 2:49 PM, TMFGalagan wrote:

    @ninjah - By investors rewarding companies, I mean bidding their share prices higher after announcing special dividends. In essence, investors conclude that their companies are worth *more* based on a simple decision to return cash rather than keep it for use elsewhere in the business. That's a reward to the company and to executives with stock-based incentives.


    dan (TMF Galagan)

  • Report this Comment On December 03, 2012, at 3:07 PM, MaxTheTerrible wrote:

    I think it's pretty simple- once the company announces a special dividend, especially a large special dividend, it immediately attracts a bunch of dividend "harvesters" - traders who only intend on holding the shares until the ex-dividend date. It has nothing to do, IMHO, with investors rewarding the company for financial prudence. If you think that investors value the company more - wait past the ex.-div. date and see if it's actually the case.

  • Report this Comment On December 03, 2012, at 3:18 PM, cancerman wrote:

    @spokanimal: spare us the drivel.

  • Report this Comment On December 03, 2012, at 4:16 PM, Mathman6577 wrote:

    A lot of the companies issuing special dividends are probably doing it to reward their shareholders but I bet a few are doing it to reward the insiders. Costco directors stand to reap $29 million and save about $8 million in taxes assuming the top rate goes up to 43.5%. Former CEO Jim Sinegal stands to make $14 million himself and save up to $4 million. The Walton family stands to save some money on taxes too since WalMart is "moving up" its regular dividend (it's not special) into 2012. But there is a lot of uncertainty with the budget discussions. Every day there is another proposal.

  • Report this Comment On December 03, 2012, at 5:38 PM, thomaspaine37 wrote:

    Is the real question: Why were these companies holding so much CASH for years? They could have done the right thing and paid dividends in years past. Think of the share price if management had paid higher dividends? Once again shareholders were not their first concern! Thomas Paine 37

  • Report this Comment On December 03, 2012, at 8:13 PM, enginear wrote:

    The way companies have been hoarding cash through this financial crisis is a little obscene... add the cash on balance sheets up for the S&P 500, Dow, and QQQ and (although I confess I don't have the figure) you'd be able to fund the U.S. military for a good long while.

    That money should not be earning interest at the rates its getting, either in your own bank account, or on their (should I say our - we are investors, after all) balance sheets. If it went into the economy, it would help resolve this crisis a bit, and spreading it through the owners of the company will get it into circulation a lot faster than leaving it where it is (if recent history is any guide).

  • Report this Comment On December 03, 2012, at 8:46 PM, spokanimal wrote:

    @enginear: First you have to have tax and government policy incentives bent on unleashing all that corporate cash... and we have neither under present leadership.

    At the same time as our President is punishing the country's most prominant job creators with higher taxes...

    ... he is also endlessly extending unemployment benefits for those who, in turn, lose their jobs as a result of that punishment.

    Socialism is a nauseating cycle of capital flight and government dependence that we used to think only happened in other countries...

    ... who ever dreamed it could happen in America.


  • Report this Comment On December 04, 2012, at 11:49 AM, 48ozhalfgallons wrote:

    Apparently, sklogw is standing upwind of those who know its direction.

  • Report this Comment On December 04, 2012, at 1:14 PM, DonkeyJunk wrote:

    The higher tax argument on job creators argument is bupkis. Taxes have been this low for a decade and were higher under Clinton. Where are the jobs, eh? The only thing lowering taxes and deregulation created was more risk taking and bubbles. If anything is slowing small businesses, it's their inability to procure loans from banks.

  • Report this Comment On December 04, 2012, at 7:22 PM, zantor2 wrote:

    Dear DAN Caplinger

    Hey DUDE!!!

    You are downer, MAN!!!

    what's your problem.

    Corporations are returning to investors some of the cash they have been hoarding.

    You sound like a 100% bummer dude=

    If they were giving away free $50 bills

    YOU would be complaining !! Hey I want a $100 ""

    PUNDITS like you make me want to puke

    NOTHING is ever a good thing,

    YOU will always spout off with

    Well WHAT IF

    yeah, Like WHAT IF you pull your head OUT of the dark hole and just take the money.

  • Report this Comment On December 05, 2012, at 10:58 AM, edacloserboy wrote:

    Is it true that Costco has to borrow the money in the bond market to pay for the special dividend?

  • Report this Comment On December 05, 2012, at 12:37 PM, edacloserboy wrote:

    Costco has 432.42 million shares outstanding. That is a payout of $3,026.94 million.

  • Report this Comment On December 05, 2012, at 12:39 PM, TMFCatoMinor wrote:


    Yep. They're actually borrowing more money than they need to pay the dividend.

  • Report this Comment On December 05, 2012, at 4:21 PM, TMFGalagan wrote:

    @zantor2 - Thanks for a good laugh!


    dan (TMF Galagan)

  • Report this Comment On December 06, 2012, at 12:51 AM, uclagsm wrote:

    There are two ways to look at ‘special dividends’ to avoid the ‘fiscal cliff’.

    One is that management has excess cash and thinks that shareholders deserve it, which is very unlikely.

    And two, that management has adopted a political view independent of what is good for shareholders. I would argue that this is the case. If you are rational facing the ‘fiscal cliff’ you should keep as much cash as possible to deal with the uncertainty to follow. These ‘special dividends’ are political statements, pure and simple.

    Anyone looking out for long term shareholders is not borrowing to pay dividends but to take advantage of super low rates and fortifying their long term financial moats against whatever may come. Anything else is not in the long term interest of shareholders.

    When you get to it after all, it is simple.

  • Report this Comment On December 08, 2012, at 1:10 AM, dunce1239 wrote:

    Share buy backs have a long and lousy record as an option for what to do with cash, so also for much M&A activity. Often management uses share buy backs to manipulate the stock price so they can exercise their options profitably. I have never heard of complaints from share holders about dividends unless they were not covered well by cash flow. Optimism about the future with obama in office is really foolish unless you are a crony capitalist in his favor.

  • Report this Comment On December 08, 2012, at 2:27 PM, downunder66 wrote:

    For the most part, the special or accelerated dividends have nothing to do with business or public shareholders - it has everything to do with the large, insider shareholders doing some tax planning. In one brilliant move, Adelson has just funded his part of the 2016 election.

  • Report this Comment On December 10, 2012, at 6:36 PM, gene132 wrote:

    I see things a bit differently-the tax increases coming (to fund "Obamacare" ) are so enormous that corporations are paying out early to avoid them. The full dimensions of the Obamacare debacle won't be know till Nacy Pelosi said "we have to pass it to know what it means".

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