How To Profit From Special Dividends

By Daniel Sparks - November 29, 2012 | Tickers: COST, DDS, GES, BKE | 0 Comments

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With a likely tax increase on U.S. dividends just around the corner, many companies are declaring special dividends. Special dividends are simply irregular dividends that are typically much larger than regular dividends. As an irregular payout to shareholders, they are difficult for investors to predict and can sometimes slip under the radar in fundamental analysis. Furthermore, investing in stocks for special dividends can be tricky business if you've never done it before. But by keeping a few things in mind it's possible to profit from special dividends and maybe even find unusually lucrative investment opportunities.

The Ins and Outs of Special Dividend Investing

Dillard's (NYSE: DDS), Guess? (NYSE: GES) Buckle (NYSE: BKE), and Costco (NASDAQ: COST) are among some of the 77 companies that have already declared special dividends this quarter as the potential tax hike on dividends approaches. It's tempting to believe a special dividend announcement is a great reason to jump in on an investment to capture the higher than usual dividend yield for your portfolio. But there are some important things to keep in mind:

1. Many times there is a sell-off after a special dividend is paid out. The sell-off could even equal the amount of the special dividend or more. This would mean that if you wanted to move on to a different stock after the special dividend was paid out you might end up with a 0% gain or even a loss.
2. Due to a potential sell-off, investors should only invest in a stock for a special dividend if they are willing to hold on to the stock for the long haul.
3. Don't miss the ex-dividend date. If you invest after the ex-dividend date to receive a special dividend, your special dividend won't be so special. In fact, you won't get a dividend at all.

Dividend Comparison

With so many companies declaring special dividends, we have the wonderful opportunity to be picky. Let's take a look and find out which of these four companies has the highest yield.

Buckle is the big winner here, with a 9.2% yield. But due to a potential sell-off after the dividend is paid out, it's not a safe play to invest solely based on the special dividend yield. So let's zoom out to look at some dividend history over the past five years. We'll look at dividend yield, dividend growth, and average payout ratio. Payout ratio is simply defined as the fraction of net income a firm pays to its stockholders in dividends.

Companies with a high 5 year average payout ratio are more likely to continue to pay out handsome dividends consistently beyond the special dividend, buffering the damage a potential sell-off could have on your portfolio. The 5 year average dividend yield can help us get a grasp on exactly how abnormal this special dividend is from a company's normal payouts. Finally, the 5 year average dividend growth rate will help us identify which companies are actually growing their dividends, year after year.

Of Dillard's, Guess, and Costco, only Guess typically pays out a decent dividend yield and has meaningfully increased its dividend over the last five years. But even for Guess, dividends are not management's top concern; with a payout ratio of 36%, 64% of earnings have been used for other purposes over the last five years.

Buckle is, again, the clear winner in the second table. With a five year average dividend yield of 6.9%, a five year average payout ratio of 93%, and a five year average dividend growth rate of 95.47% it stands out with a very solid dividend history. Buckle manages to maintain a historical average dividend yield of 6.9% simply because special dividends are nothing new for Buckle; since 2006 Buckle has paid out a special dividend every year except 2007. But an investor won't see a 6.9% yield listed on Buckle's Google Finance stock quote page; special dividends are not automatically calculated into the forward-looking dividend yield shown on stock quote pages because they are not "regular," so they can go under the radar.

Finally, with ten years of upward trending free cash flow and a five year average payout ratio of 95%, the sustainability of Buckle's dividend going forward is highly reliable. This means investors can jump in for the nice 9.2% yield on the special dividend today and mostly likely continue to enjoy special dividends and high yields in the future.

The Bottom Line

As companies continue to announce special dividends ahead of the potential tax hike on U.S. dividends, more and more opportunities will reveal themselves. It's a great chance to pick up a higher yield. But remember to maintain a long-term outlook, be aware of potential sell-offs after payouts, and invest before the ex-dividend date. In the meantime, Buckle offers a compelling opportunity with a 9.2% special dividend yield backed by a solid history of strong dividends. 

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