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.