Throughout 2012, we’ve seen a huge surge in special dividends, with 59 companies in the Russell 3000 declaring special dividends from September to November compared to just 15 during the same period last year. The impetus is obvious: the impending fiscal cliff has left both companies and investors wondering what to do with the mountains of cash sitting on pristine balance sheets and low return prospects. As a result, companies across different sectors are declaring special one-time dividends.
Costco (click ticker for report: ) will pay a one-time special dividend of $7 per share (amounting to $3 billion) as a reward to shareholders, while Tyson Foods (click ticker for report: ) declared a special one-time payment of $0.20 per share. Wynn Resorts (click ticker for report: ) also declared a one-time dividend of $8 per share, though we think CEO and founder Steve Wynn had several ulterior motives (i.e. dodging a huge tax bill for himself).
The reasons are obvious: dividend taxes will most likely rise next year and shareholders will avoid higher tax bills if returns are paid out now. Further, companies have used low interest rates to reduce borrowing costs, while profit margins have increased as companies have become more efficient, resulting in healthy corporate balance sheets. Companies now have enormous amounts of cash, but remain hesitant about investing for the future, given the laundry list of macroeconomic concerns including the European debt solvency issues, the fiscal cliff in the US, and potentially slower long-term growth rates in China.
In our view, returning cash to income-starved shareholders makes perfect sense in this low-interest rate environment, and we expect the trend to continue into December. The only thing that doesn’t make sense to us is why companies haven’t been doing this consistently for a while now. When we look back at all the value-destroying acquisitions companies have made over the past several years—HP (click ticker for report: ) and Autonomy come to mind—we think this trend should have started prior to the looming fiscal cliff. Domino’s Pizza (click ticker for report: ), for example, has declared special dividends in the past and has also provided fantastic returns to shareholders.
Overall, we like the trend, especially since it provides incentive for shareholders to purchase companies generating strong free cash flow. Though the activity may not persist into the New Year, a number of companies could pay out a special dividend in December. One company that seems like a likely candidate is Microsoft (click ticker for report: ). Not only does the firm have large shareholders like Bill Gates and CEO Steve Ballmer that would benefit from a one-time payout, but the company also has a $66 billion cash stockpile. However, Gates and Ballmer aren’t hurting for money, so we also wouldn’t be surprised to see the company stand pat, especially given the uncertainty with respect to the shift to mobile.
Intel (click ticker for report: ) is another company that could declare a special dividend, thanks to its enormous cash hoard and willingness to return cash to shareholders. However, with a yield of approximately 4.5% at current values, we do not think shareholders are too worried about the company providing adequate returns of capital.
Another few firms in tech, namely Qualcomm (click ticker for report: ) and Cisco (click ticker for report: ), are special-dividend candidates. Both companies are cash cows, and Qualcomm in particular is experiencing fantastic growth thanks to the boom in smartphones. Cisco, on the other hand, has seen its shares bounce around in the range of $15-$20 all year long, and a special dividend could be a more timely way of providing returns to shareholders than share repurchases (even though the company is undervalued). Though we think both firms could pay out a one-time dividend before the end of the year, we’ve heard of no specific indications that either will do so. And of course, Apple (click ticker for report: ) will always be mentioned as a special-dividend candidate as long as it has a huge cash hoard, but we don’t think it’s a very “Apple” thing to do (at least for now).
Aside from tech giants, we don’t see too many firms that could potentially pay outsize special dividends. Biochemical maker Sigma-Aldrich (click ticker for report: ) has a relatively strong balance sheet, as well as a strong Valuentum Dividend Cushion score, but again, we have no assurance that it will declare one. Plus, it may make more sense for economically-sensitive companies like those in the chemicals space to retain cash in the event of a prolonged economic slump.
Overall, we remain encouraged by the special dividends trend, and we like the flexibility it provides management with respect to capital allocation. Needless to say, we don’t advocate speculating on firms that may issue a special dividend, but already undervalued names such as Microsoft and Intel could get a much-needed positive catalyst in the event that a special dividend is declared.