By Jack N., Communications Analyst and Blog Contributor
Special dividends have been all the rage lately, and I have to say I’m scratching my head over companies urging to pay them out. Although, I have to admit, part of my confusion could be related to my overall ambivalence about dividends.
A special dividend is a one-time payment made to shareholders that’s usually much larger than a company’s regular quarterly dividend. Some companies that pay no dividends will occasionally pay out a special dividend.
A Fiscal Cliff Reaction
So why are special dividend announcements becoming more common these days? Blame (or credit) could go to the fiscal cliff. If no action is taken in Washington over the next couple of weeks, dividends will be taxed at ordinary income tax rates in 2013, rather than lower capital gains rates. By receiving dividends in 2012, rather than 2013, shareholders could take advantage of potentially lower tax rates.
But is a company really doing you a favor by paying a special dividend?
When a company pays a dividend (special or regular), the share price typically falls on the ex-dividend date by the amount of the dividend. That’s because the special dividend (like any other dividend) is simply a redistribution of cash from the company’s balance sheet to stockholders’ pockets. You might be $100 richer, but the company is $100 poorer, and the stock price invariably will fall to reflect that.
A Taxing Event
Yes, it feels good to get a fat dividend check in 2012. And it’s nice that by getting the dividend in 2012, you might pay a lower tax rate than you would in 2013. But you still have to pay taxes on that dividend. From a shareholder perspective, I think a share buyback might make more sense. With fewer shares outstanding, the price per share should increase. There wouldn’t be any immediate tax consequences. When you do sell the stock, it will be at the lower capital gains rate (if you hold it for more than a year), rather than ordinary income.
I couldn’t find any research suggesting that companies paying special dividends outperformed those that don’t. However, investing in companies with a long history of growing dividends can be a good strategy. Screening for five-year dividend growth might be a better starting point than looking for companies paying special dividends.
Which would you favor: A company paying a steady dividend or a company consistently buying back shares?
Jack N. is a communications analyst at Scottrade. He works to demystify the markets and the economy for all types of investors and traders.
Also of Interest:
- Podcast: Can You Make Money on Special Dividends?
- A Look at the Possible Impacts of Companies Buying Back Shares
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