The Special Dividend Train Runs Amok
Jamie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It has long been said that Wall Street is absent of original unique thinking. It is a place where actions taken by one are usually imitated by the rest.
Something about imitation being the sincerest form of flattery.
Or in the case of the latest special dividend declaration craze the best way to distribute a corporate horde of cash that has been building on the strength of easy money policy and tight fisted managements still reluctant to reinvest in future profits.
The impetus for the latest trend is the coming Fiscal Cliff and what many perceive to be a guarantee increase in taxes including a higher tax rate for corporate dividends.
Put two and two together and one can easily see how executives at the board level are swayed by the argument: give the cash now as we have no better use.
The latest and most certainly not the last to the game is Costco (NASDAQ: COST). The wholesale discount retailer announced a special $7 per share dividend to be paid on December 18 – beating the year-end deadline. The move will take the weight of $3 billion off the company’s balance sheet and replace it with debt, albeit cheap debt.
Investors cheered the news with the stock soaring more than 5% on Wednesday after the news was announced, but should they be so enthusiastic? Sure it’s great to get the cash – better now than never, but at what cost?
Costco has a premium valuation. Analysts currently on average expect the company to grow profits by 13% in the fiscal year ending Aug. 31, 2013. At current prices shares trade for 23 times current fiscal year estimated profits.
Why do investors usually pay such a premium?
They pay it because the underlying company is growing profits at a rapid clip. I would hardly call 13% profit growth rapid. It’s a nice number, sure, but not near what similar growth stories are producing.
Now, take away that $3 billion and what do you have? Well in the short term you have a higher stock price. I suppose in the era of what have you done lately that might be okay, but it does portend trouble in my opinion.
My read on the situation is that hyper growth at Costco is a thing of the past. Who cares if they pay a big fat special dividend? In the long road I would rather see them reinvest that cash to get me closer to a 20% per annum profit growth rate, but hey, that’s just me.
Costco is hardly alone. Prior to their special dividend announcement casino operator Las Vegas Sands (NYSE: LVS) declared its own special dividend. Using its huge cash generating machine to enhance shareholder value, Las Vegas Sands rewarded shareholders with a $2.75 per share special dividend.
Is there not a piece of desert or some other locale that Las Vegas Sands could develop with that cash instead of paying a dividend? Okay, I’ll admit it, I loathe dividends.
They just don’t make sense to me and now everyone is rushing to beat the year-end deadline.
Again, let’s look at valuation on Las Vegas Sands to see if shares should be owned here because of these rich dividends. Analysts are expecting Las Vegas Sands to grow profits by 18% from the current year to the next. At current prices, shares trade for 21 times current year estimated earnings.
So, we have another expensive stock, but in this case the expected profit growth is sufficiently high to justify the higher valuation. Does using cash to pay a special dividend make sense in the case of Las Vegas Sands?
I don’t think so. I would still rather see that cash put to better use.
There really is only one company I can see that would be justified in paying a special dividend to beat the coming change in dividend tax rates and that would be Apple (NASDAQ: AAPL).
The technology juggernaut has yet to declare a special dividend, but they and they alone really should. Their global domination is apparent and only growing stronger. The amount of cash generated is simply staggering.
More importantly shares are cheap today relative to expected growth. Analysts on average expect Apple to grow profits by 12% in the current fiscal year ending September 30, 2013. At current prices shares trade for a modest 12 times current fiscal year estimated earnings.
The valuation metrics at Apple support the idea of a special dividend. Where else are they going to put the cash? In addition, the company has a long history of crushing analyst estimates. It could be the stock is even cheaper than you might think.
I’d buy Apple before that special dividend is announced – assuming an announcement is forthcoming. Shares could absolutely soar on the news depending on what that news is.
jamdlu has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Costco Wholesale. Motley Fool newsletter services recommend Apple and Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!