As you may know, many shares pay dividends. A dividend is a portion of a company's earnings that it pays to its shareholders. Usually this payment happens once or twice a year.
And because they offer this added benefit of a regular income stream, income-seekers love dividend-paying stocks.
But occasionally, companies surprise investors by electing to pay a ‘special dividend'.
Special dividends don't get paid often but when they do, they are often higher than a company's normal dividend. In some case, three, four, even five times higher!
That's what makes them an attractive investment opportunity for income investors.
So how do special dividends come about?
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Three reasons why companies pay special dividends
There are various reasons why a company might declare a special dividend.
For example, the company generates a large amount of excess cash or it achieves substantially strong profit growth. It could then distribute that cash or profits to its shareholders through a special dividend.
For example, in 2018 food producer, Quantum Foods declared a 49c special dividend thanks to superior cash generation.
Another reason is when a company restructures its business by selling or spinning off one of its subsidiary’s to its shareholders. In other words, it basically “sells” the business to its shareholders, who then receive the profits in the form of special dividends.
For example, in 2018 Micromega sold its occupational and safety business, NOSA for R747.8 million to Global Alternative Asset Manager, The Carlyle Group.
Due to profits generated from the sale, Micromega paid investors a 240c special dividend. This special dividend was more than FIVE TIMES HIGHER than its normal dividend of 44c per share it paid in 2017.
Also a last reason is when a company wins a lawsuit or a claim. They will sometimes pay the proceeds in the form of a special dividend to shareholders.
While special dividends sound great in theory, there is a drawback in investing for them.
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A major drawback in investing for special dividends
At first glance, a special dividend might seem like a great thing, as it puts extra cash in investors' pockets. However, some investors regard special dividends as a sign that the issuing company has run out of opportunities to grow the business.
And this can cause a negative reaction from investors.
This happened to Microsoft back in 2004.
But here’s what you need to keep in mind…
As long as the issuing company demonstrates future growth potential, then there’s no need to see this as a negative.
At the end of the day, special dividends are a great way to earn extra income. Just make sure the company that pays a special dividend, has the potential to generate awesome capital growth as well.
See you next week,
Managing Editor, Real Wealth
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