Bonanza: At results time, some companies are also announcing significant one-off bonuses in the form of ‘special dividends’
Following a famine during lockdown, dividend payments are beginning to roar back and create quite a tempting income feast.
And it’s not just regular dividends, typically paid half-yearly or quarterly, that are creating the feeding frenzy.
At results time, some companies are also announcing significant one-off bonuses in the form of ‘special dividends’ after finding surplus cash on their balance sheet.
According to dividend monitoring expert Link Group, £1.4billion of special dividends were paid during the second quarter of this year by UK listed companies – far more than during the whole of 2020.
The momentum is such that Link Group forecasts that UK special dividends will total a staggering £12billion for 2021 as whole.
These dividends can be much higher than regular dividends, sometimes even amounting to 20per cent or more of a company’s share price.
Why do companies pay special dividends?
Some of the biggest special dividend payouts occur when a company has raised a lot of cash by downsizing – or spinning off a subsidiary.
For example, in February Tesco paid a special dividend of 51 pence per share – then worth just over £3 each – following the sale of its Asian supermarkets.
And, last month, water company Pennon paid a special dividend of £3.55 per share – then worth about £17 each – after selling its waste management business.
But special dividends can simply be paid because a company has enjoyed a purple patch in terms of earnings.
Rather than using this money to make an acquisition, invest in research and development, or improve other aspects of its operations, it decides to give a slice to shareholders.
Paying a special dividend can prove a more attractive way of doing this than raising the regular dividend, which may not prove sustainable in the long run.
Although special dividends were traditionally viewed as a one-off payment, there is now a trend for some companies to use them more regularly.
For example, mining companies Ferrexpo and Rio Tinto have already declared two special dividends each this year as a result of booming commodity prices, having paid others in the past.
Will Walker-Arnott is senior investment manager at wealth manager Charles Stanley.
He says: ‘There is a general trend in the commodity sector to move away from acquisitions and investing in production to returning money to investors.
‘There was a period when it was felt shareholders were losing out as a result of companies being in the habit of making sometimes costly and expensive acquisitions. Now, they are being more disciplined with their balance sheets.’
Insurer Admiral, which paid a special dividend of 22.4 pence per share in June (then worth just over £31), and retailer Next – which will be paying £1.10 per share next month (its shares are currently worth just over £80) – operate in less volatile business sectors.
But they have found the payment of special dividends a good way of returning surplus cash to shareholders when trading has been strong. Guy Foster is chief strategist at wealth manager Brewin Dolphin.
He says: ‘The interesting thing about Admiral is that it has all the capital it needs to run its business. It doesn’t need to reinvest money to increase its profits, so it pays a special dividend virtually every year.
‘Next also has good capital allocation and has made regular use of special dividends.’
Use of both one-off and more regular special dividends should accelerate as a growing number of companies realise they have accumulated spare cash as a result of faring better than expected during the pandemic.
In particular, management could be worried that having a surplus of cash on their balance sheets might make them vulnerable to being bought by a private equity predator looking for value not reflected in the company’s share price.
There can be drawbacks
Special dividends are not without potential drawbacks. Those wishing to reinvest them to buy more shares may have to pay brokerage fees, while a strong pound can reduce the value of payments made by multinationals in different currencies.
Indeed, Link Group reports that in the second quarter of this year UK special dividends as a whole were reduced by about 10 per cent because 80 per cent of them were declared in US dollars.
More importantly, as with regular dividends, the share price of companies paying special dividends usually falls on the ‘ex-dividend date’ – the point at which you need to own shares to qualify for the dividend payment.
As a broad rule of thumb, it falls by the amount of the special dividend being paid out, reflecting the resultant decrease in the value of the company. So, what you gain on the roundabouts you lose on the swings.
But sometimes the share price falls by less than the dividend amount – known as ‘going ex-dividend well’. On other occasions it falls by more than the dividend amount – known as ‘going ex-dividend badly’.
Brewin Dolphin’s Foster says: ‘If it goes ex-dividend badly, it is typically the case that investors don’t think the company can afford to pay that dividend. But, if it goes ex-dividend well, it’s because people want to hold shares in the company.
‘The most important factor is that the company’s management is effecting good capital allocation, making the right decisions about whether they should be investing in building a new factory or returning money to shareholders.’
He adds: ‘If, for example, a growth company making regular healthy profits suddenly pays out a special dividend, then investors might have made higher returns if the company had simply reinvested all of the profits in the business.’
Some critics of special dividends even argue that their payment can be a sign that a company has struggled to identify new investment or acquisition opportunities.
How to profit from special dividends
Even though share prices normally fall on the ex-dividend date, they tend to increase when details of the special dividend is announced.
So astute investors can potentially make money by identifying those companies likely to make such announcements.
Are there, for example, certain sectors looking particularly buoyant or individual businesses looking likely to sell off significant assets? Even if the management opts instead for share buybacks (see panel, below left), you should still benefit from an increased share price.
It’s a bit like identifying companies that will be takeover targets. Both are speculative strategies and there is no guarantee that either the takeover or special dividend will happen.
But if you restrict speculation to companies with strong financial fundamentals and regard any special dividends that arise as the icing on the cake, you shouldn’t go far wrong.
Justin Urquhart Stewart is cofounder of investment platform Regionally.
He says: ‘Even if you don’t feel confident identifying individual companies, you could look at a sector with a lot of issues in common.
‘I wouldn’t be surprised if most major British banks start paying special dividends by the end of the year.
‘I believe the drinks sector could also present special dividend opportunities, as could the consumer products sector, where companies such as Unilever and Reckitt Benckiser have strong international brands, the value of which aren’t properly reflected in their share prices.’
However, some experts stress that they do not regard trying to sniff out stocks that might pay a special dividend as a sound strategy. Some also regard basing a portfolio simply around a search for high yields and headline income as unwise.
Susannah Streeter, senior investment and markets analyst at wealth manager Hargreaves Lansdown, says: ‘Investors need to balance dividend returns with prospects for growth in the value of their shares.
‘Companies should also be sought out that reinvest profits into the business to maintain growth.’
Rather than trying to narrow down the number of stocks held, she says: ‘A growing portfolio is important, as over time this also means the income it produces will rise, which helps to offset the effects of inflation.’
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