Lately, a slew of companies have been dumping cash on their shareholders in the form of a surprise dividend.They’ve been doing this because of the fiscal cliff. Specifically, at the end of the year, Bush-era tax cuts will expire causing the dividend tax to surge from 15 per cent to up to 43.5 per cent. By paying this cash out now, shareholders will be able to take advantage of the low current rate.
However, no one is suggesting that you use these lists to buy stocks in anticipation of a windfall.
“We remind investors not to chase ―special dividend paying stocks,” writes Oppenheimer’s John Stoltzfus. “Special dividends are traditionally designed to reward existing shareholders.
“New acquirers of the stock just ahead of the ex-date will receive a dividend along with longer-term holders, but as the stock price is adjusted downward in the amount of the dividend, the recent buyer will incur a tax liability on a part of the price just paid for the shares as represented by the dividend.”
Stoltzfus makes two important points here:
- “The stock price is adjusted downward in the amount of the dividend.” — This is basic balance sheet theory. If a company reduces its cash balance through a payout, then the equity or book value of the company falls by that same amount. In other words, a trader buying a stock for a one-time dividend is effectively giving a company money with the hope of getting some of that money right back.
- “The recent buyer will incur a tax liability.” — A dividend will get taxed. 15 per cent is lower than 43.5 per cent. But 15 per cent is higher than zero per cent, which is the tax on not doing anything.
By buying a stock in anticipation of a special dividend, you are effectively giving a company money with the hope of getting some of it back less taxes.
All things being equal, this is the dumbest thing you can do in the stock market right now.
A Quick Note About Markets
Markets are notoriously irrational. So, while in theory a stock price should fall by around the amount of a dividend, frequently it actually does quite the opposite.
In a September research note, Goldman’s Robert Boroujerdi looked at the performance of stocks after a special dividend:
A Word on Performance
Our analysis indicates that since 2000 over 75% of companies that declared a special dividend outperformed the S&P 500 in the two days post. The average outperformance over the two days and the 3 months following the announcement was 330bp and 380bp, respectively. On the ex-date, the average stock declined by less than what was indicated.
For what it’s worth.