Investors could see more special dividend payouts in the weeks ahead as companies brimming with cash amid a market runup look to reward their shareholders.
While special dividends are often welcomed as a surprise bonus, some investors warn the one-off cash payments don’t necessarily reflect the long-term health of a company and its growth potential. Some would prefer the money to be reinvested back in the business.
Special dividends are often made when a company sells an asset or is throwing off more cash than expected because of surging demand and/or rising prices for its goods and services.
An example is the special dividend of US$12 a share that Dorel Industries Inc. recently said it would pay from a chunk of the US$735-million the company netted from the recent sale of its bicycle unit to Dutch transport conglomerate Pon Holdings. Last fall, Tourmaline Oil Corp. paid out a special dividend of 75 cents a share and said more payouts would come if its commodity prices continue to rise.
“There are so many companies that are flush with cash,” says Jennifer Radman, head of investments at Caldwell Investment Management Ltd., citing energy and other commodity sectors, such as forestry and mining, where prices have surged.
Ms. Radman says commodity prices have also been volatile “and investors are really not giving full credit for all the cash that’s coming into these companies.”
As an institutional investor, Ms. Radman says special dividends are considered a viable option as long as the company has paid down debt and isn’t overlooking an opportunity to use excess funds to make an acquisition or invest directly in the business.
“If there are good growth opportunities, sure, go ahead and invest in those. But if they’re not, don’t go chasing and spending on things that aren’t going to earn a good return on that capital.”
Stephen Duench, vice-president and portfolio manager at AGF Investments Inc., describes special dividends as the “holy grail” for investors not only because they provide a surprise payout but they also often boost the stock price, at least temporarily.
“Companies know this – they know that it’s a great way to return capital to shareholders,” he says.
Also, companies don’t like to have too much cash built up on their balance sheets and Mr. Duench believes special dividends are “ripe” right now as a result of the economic bounce-back from the pandemic-induced recession in early 2020.
“You have all of this record free cash flow across the market being created, especially in certain sectors with low debt and strong balance sheets,” he says. “So that’s where we’re going to start to see not just dividend growth expectations overshooting, but special dividend announcements will also probably come at a higher cadence than people anticipate.”
While certain sectors are currently better positioned than others to provide special dividends, such as commodities, industrials and consumer discretionary, Mr. Duench says it’s usually stock-specific.
“Some companies want to pay down their debt to zero, while some companies want to be within certain ranges and anything above that they just like paying back to shareholders,” he says.
And while there’s no secret formula to figuring out whether or when a company will pay a special dividend, Mr. Duench says investors could try to anticipate it by reviewing the company’s books. For instance, they could check whether free cash flow is higher compared with historical levels, what the company’s debt level is, and whether there’s a history of paying a special dividend. Also, he says many of these companies already pay regular monthly or quarterly dividends.
Jason Del Vicario, a portfolio manager with the Hillside Wealth Management team at iA Private Wealth Inc., isn’t a fan of special dividends, or even regular dividends, “particularly when the money can be reinvested in the business and generate above-average returns on capital.”
He points to Constellation Software Inc., a company his firm owns, which told shareholders a year ago that it would stop paying special dividends “in all but the most compelling circumstances.”
Constellation chairman Mark Leonard also said at the time the company could cut the regular quarterly dividend if it could find deals to spend the money on instead. (The regular dividend is still in place as of today.)
Mr. Del Vicario says many investors often overlook the tax implications of receiving dividends.
“All things being equal, investors may be better off selling their shares if they need the money,” he says. “It’s more efficient to have your money compounding within the company, by owning shares of the company than for the company to pay you dividends.”
Still, he believes special dividends are better than a company “lighting the money on fire” by overexpanding or overspending on acquisitions or other risky deals.
“But where we really lean into is companies that have a business model where they are actively reinvesting money back into the business to create a flywheel effect,” he says. “We’d really rather they keep that money and generate a great rate of return on it.”
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