Many investors turn to the members of the S&P 500 (SNPINDEX:^GSPC) to find solid dividend stocks with track records of excellence. But if you look at traditional screening tools, you'll miss out on a lot of stocks that pay much higher yields than most investors think. That's because special dividends have gotten a lot more popular, and companies that are unwilling to commit to high dividends quarter after quarter are more comfortable making special dividends at regular intervals to reward shareholders.
Did high yield get a bad reputation?
Over the years, many high-yield stocks in the S&P 500 have eventually had to reduce their dividend payouts, generally hitting shareholders twice as income levels fell and stock prices plunged after dividend cuts. Along atop the S&P is Windstream (NASDAQ:WIN), a rural telecom that still pays an 11% yield even as all of its peers have cut their dividends substantially and fallen well-below double-digit yield status. Even Windstream troubles many dividend investors, who points to earnings that are entirely insufficient to support the payout. Even more generous metrics based on adjusted cash flows suggest that Windstream stretches its resources in order to support its dividend, and many fear that the stock will eventually reach the breaking point.
But beyond the rural telecom segment, many of the stocks that have paid the most to shareholders over the past 12 months have done so through what the companies call special dividend payments rather than regular ones. Diamond Offshore Drilling (NYSE:DO) is the most obvious example of this; for more than three years, Diamond Offshore has paid a $0.125 regular quarterly dividend alongside a $0.75 supplemental special quarterly dividend. Shareholders can't tell the difference -- to them, the $3.50 per share annual dividend rate equates to a 6.5% dividend yield. But to many investors, the "regular" dividend yield of less than 1% makes Diamond Offshore look unattractive as a dividend stock.
The same is true for other companies as well. CME Group (NASDAQ:CME) pays a quarterly dividend of $0.47 per share, which amounts to less than a 3% yield. But in December, it paid a $2.60 per share special dividend to investors, doubling its special dividend from the previous year and boosting its effective yield above 6%.
Why go special?
The reason why many companies choose to go with special dividends is that it gives them more flexibility to control how they return capital to shareholders. When a company establishes a regular quarterly dividend, reducing it for any reason -- even if it's completely justified -- can bring negative publicity from investors who had taken the previous payout for granted.
By contrast, the pressure to continue special dividends isn't nearly as strong. Moreover, companies can tie special dividend amounts to certain conditions or metrics much more effectively, helping make their payouts predictable to shareholders and making rises and falls less of a shock.
So when you're looking for ways to find strong dividend stocks, don't forget about companies that rely on special dividends for much of their total payouts to shareholders. Remembering those key dividend stocks can open up possibilities you never knew existed.