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Don’t Lose Your Head Over Special Dividends

Beyond the regular holiday-season hullabaloo, this year has had something extra-special in store for dividend investors…

Namely, companies are emerging in hordes to provide gifts to shareholders in the form of special dividends.

It’s a reasonable thing to do given the infamous fiscal cliff that has every investor, board room (and many tax payers) fearing for the New Year.

We all know the score: If a deal fails to materialize (and even if one does) tax rates on dividends may be much higher next year. Or not.

Long story short, the outcome is anyone’s guess.

Of course, investors – fearful as they are over the approaching cliff – are seeing the recent windfall of declarations as a boon.

But, as always, wherever there’s a crowd, you can bet there’s some madness in the mix…

Don’t Forget the Basics

Dividends paid and increased consistently is the absolute basis of level-headed income investing. Just as Louis Basenese reminded you yesterday, you can’t forget the basics.

So be forewarned: When a company pays a special dividend it’s sometimes a reflection of desperation on the part of the issuer.

Here’s why…

One of the purposes of dividend payments is to distribute capital to the shareholders. And this capital distribution is like the cheese in the mousetrap.

Whereas in the good old days, dividends were the key characteristic of any stock’s appeal, dividends these days are often considered secondary benefits. That’s especially true in the case of special dividends.

Frequently, companies begin paying dividends only after they’ve matured – i.e are no longer equity growth stocks.

Facing slower growth prospects, many former high-fliers find themselves cash rich but nonetheless saddled with stagnant share prices. Hence, they start distributing that cash – either regularly (good) or as a special dividend (possibly good) – to keep existing shareholders interested and hopefully attract new ones.

So, although there’s nothing fundamentally wrong with a special dividend, for income investors, there’s nothing fundamentally right with them, either.

Instead, think of the stock paying a special dividend just as you would any other potential dividend investment. Consider it as a long-term commitment, not something to jump into – and subsequently out of – just to collect the dividend.

Buying, collecting the dividend and then selling is called a dividend capture strategy. And to put it mildly, it’s risky and potentially bogus for one simple reason: In most cases, a stock’s share price adjusts lower the same amount of the distribution.

To top it off, selling volume in the wake of the dividend could be heavy, pushing the price even lower, and possibly eliminating the benefit of the dividend for Johnny-come-lately investors.

A Mixed Bag of Special Dividends Declarations

Now that you’ve been duly warned about the perils of the dividend capture strategy, here’s a collection of stocks with recent special dividend declarations. As you’ll see, some are better than others…

~ Oracle Corporation (ORCL)

The technology behemoth, led by the iconic Larry Ellison, announced a special dividend Wednesday morning. But this dividend isn’t really “special,” as it’s an accelerated payment of dividends that were going to be paid in 2013 anyway.

Shareholders will receive $0.18 per share this month, instead of next year, and the total payment amounts to almost $200 million.

Oracle has a yield of around 0.75%, so it’s not likely to be held in many income oriented portfolios. If you wouldn’t own it anyways, don’t buy it now just because of the declaration.

~ Whole Foods Market, Inc. (WFM)

This high-end grocery chain for the quality-conscious announced its special dividend on Friday, November 30 with an ex-dividend date of December 06, 2012.

The dividend payment will be $2 per share, scheduled for December 21, 2012.

This is a significant increase over its $0.14 regular quarterly dividend. But unlike Oracle’s, this really is a “special” dividend, as the regular dividends (small as they are) will probably continue next year as usual.

Whole Food’s regular dividend yields less than 1% annually which means, like ORCL, it is probably not in the portfolio of many disciplined dividend investors. The company previously suspended the dividend in 2008, reinstated it in 2011 and has paid regularly since.

The stock is up a tremendous amount since the financial crisis. From a low of less than $8.00 per share in November 2008, it traded as high as $101.99 this year.

So while the yield is low, performance is excellent and the stock might make a great dividend growth candidate.

~ Tessco Technologies Incorporated (TESS)

This lesser known telecommunications company declared a special dividend of $0.75 on December 3, 2012. The dividend will be paid December 27 to shareholders of record as of December 13.

Historically, Tessco is strong. It started paying dividends in August 2009 and has paid one every quarter since. It’s also increased the payout over the same period, taking it from $0.07 per share to the $0.18 per share last paid November 9, 2012.

The stock’s also seen its share price increase dramatically over the past few years, rising from a low of $3.70 in March 2009 to a recent price above $22.00 per share.

Given its robust history of payments and increases, Tessco is a candidate for purchase, apart from its special dividend.

Bottom line: Special dividends have appeal. Who doesn’t want to receive extra cash (especially this time of year)?

But the joy of getting paid a lump of cash can be quickly quelled by a diminished share price. So don’t give special dividends “special” treatment. Fundamentals apply here as elsewhere.

Safe investing,

Steve Gunn