What happened

Shares of Cango (CANG -2.82%) were up 10.6% as of 1:22 p.m. ET on Wednesday after the Chinese automotive transaction service platform operator declared a special dividend to shareholders on Tuesday. 

The dividend was set at $0.50 per ordinary share, or $1 per American depositary share, and will be paid on Nov. 23 to investors who owned shares as of Oct. 24. The special dividend represents a high yield of 40% on the current stock price and explains why investors were rushing to buy the stock.

However, risk-averse investors should be cautious before following the herd.    

So what

With 12 days to go before the cutoff date, investors are rushing to buy the stock to be eligible for the dividend. Special dividends are different from regular payouts, which are typically paid on a quarterly schedule. Costco Wholesale is known for intermittently rewarding shareholders with large special dividends on top of its quarterly dividends.

Companies that can pay special dividends are usually profitable, with shareholder-friendly management teams that look for opportunities to distribute excess cash to investors.

In the case of Cango, the weak economic environment in China caused revenues to fall 70% year over year in the second quarter. The company also reported a net loss of $42 million on total revenue of $43 million. But it has a strong balance sheet, with $509 million in cash and short-term investments and $41 million in long-term debt. 

Based on the number of ordinary shares outstanding, the special dividend will amount to $69 million, which the company can easily afford from its cash balance. 

Now what

Investors should know that once the dividend is paid on Nov. 23, the stock price is likely to drop to compensate for the large cash distribution. Cango is a relatively small business operating in an automotive industry that is susceptible to swings in economic cycles.

Its share price is down 46% over the last three years, and the risks of investing in this small-cap stock may not be worth the high yield that investors are chasing.