Yesterday, Costco Wholesale Corporation (NasdaqGS: COST) joined a growing list of major U.S. companies to offer a special dividend. The big-box retailer said it would pay $7 a share, or a total of $3.07 billion, on December 18 to shareholders of record on December 10.
On Monday, Brown-Forman Corp. (NYSE: BF.B), maker of Jack Daniel’s whisky, said it would make a one-time payout of $4 a share in December. Department store operator Dillard’s (NYSE: DDS) announced a $5-a-share special dividend that same day. And on Tuesday, casino operator Las Vegas Sands Corp. (NYSE: LVS) followed suit with a $2.75-a-share offering.
Companies Are Racing Against the Fiscal Cliff
The wave of special dividends has been triggered by the looming fiscal cliff. If the president and Congress can’t negotiate a solution, dividend taxes could jump from their current level of 15% to as high as 43.4% for some investors when you factor in a 3.8% surcharge on higher-income Americans’ investment income to pay for Obamacare.
As Investing Daily’s Roger Conrad wrote back in August, the most likely outcome to the fiscal cliff remains a compromise agreement, but even so, dividend taxes seem likely to rise: even under the best-case scenario, in which the current rate of 15% is retained, the added 3.8% surcharge would bring it up to 18.8%.
Companies would normally return cash to investors by simply increasing their regular dividends. But the potential for a potentially steep dividend-tax hike makes that option much less appealing. Hence the rising tide of one-time payouts.
Special Dividends Are a Sign of a Healthy Business
However, the best way to profit is usually not from the special dividend itself, as Investing Daily’s Jim Fink wrote in “Special Dividends Can Create Trading Opportunities”:
“I don’t recommend buying stocks just to receive special dividends. Keep in mind that the stock usually falls by the amount of the dividend received on the ex-dividend date, so it’s a wash. What you gain in the dividend, you lose in a lower stock price. Actually, it’s less than a wash since you have to pay taxes on the dividend received.”
Instead, as Fink wrote in September, the secret lies in spotting stocks likely to pay a special dividend ahead of time and profiting from the resulting gain in the stock price between the announcement date and the ex-dividend date. This week’s special dividend payers, for example, are already off to a strong start: Costco rose 6.3% yesterday, while Las Vegas Sands is up 6.7% since its announcement. Dillard’s has risen 3.7%.
The extra income is only one reason why investors are attracted to these stocks. Special dividends are also a sign of a strong company whose management believes it has the cash holdings, growth potential and business wherewithal to manage the cost of the payout.
Earmarks of a Special Dividend Candidate
So how do you spot these high-quality companies ahead of time? The first and most obvious factor is to zero in on stocks that already pay dividends. In addition, a high level of insider ownership is a crucial aspect, as Abram Brown of Forbes writes:
“Look for companies with a hefty amount of insider ownership. Above all else, this seems to matter most. Businesses dominated by founders and long-time employees will want to reward these veterans.”
As examples, he points to Las Vegas Sands, which is 52.6% owned by insiders, and Brown-Forman, at 29.3%. Dillard’s also ranks highly, at 40.9%
A high cash balance is also an important factor, along with low debt. That explains yesterday’s move by Costco, which is only 1% insider controlled but has $4.9 billion of cash and short-term investments on its balance sheet. That’s well above its $1.6 billion of debt.
Three Potential Special Dividend Payers to Watch
Here are three other companies with the potential to make a one-time payout to investors. Keep in mind that time is growing short to make this move; a deal to avert the fiscal cliff will have to be in place before January 1.
- Apple (NasdaqGS: AAPL) started paying a $2.65-a-share quarterly dividend in August, for a 1.82% annualized yield. The company had been under pressure for years to initiate a regular dividend to return some of its massive cash hoard to investors. Still, Apple ended its latest quarter with cash of $121.25 billion, up from $117.22 billion in the previous quarter.
- Wal-Mart (NasdaqGS: WMT) pays a regular quarterly dividend of $0.40, for a 2.25% yield. In light of the fiscal cliff, the company has already moved its regularly scheduled January dividend payment up to the end of December, so the potential tax hike is already on its radar. The Walton family still owns over 48% of Wal-Mart. The company ended its fiscal third quarter with cash and cash equivalents of $8.64 billion, up from $7.06 billion a year ago. Its long-term debt of $38.9 billion is down from $44.9 billion in Q3 2011.
- Yahoo! (NasdaqGS: YHOO) doesn’t pay a regular dividend, but it just got a big windfall from its $7.1-billion sale of half its stake in Alibaba Group. As well, CEO Marissa Mayer has already said she will return $3 billion of the proceeds to shareholders. There’s no reason not to do so as a special dividend.
In Jim Fink’s September article, “Fiscal Cliff and Possible Dividend Hike Will Spur Special Dividends,” he uses a set of precise criteria to come up with a list of 7 potential special dividend payers. His metrics include: insider ownership of at least 30%; free cash flow that is greater than 10% of a stock’s market cap; and a debt-to-cash-flow ratio of less than 30%. Click here to see the list of stocks that Fink’s screen returned.
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