Looking for a Shower of Dividends

When it comes to the cash payout of special dividends, prolonged shareholder activism is usually what gets the job done -- and over the coming weeks and months, investors may be treated to cash payouts thanks to the activist hand of none other than Uncle Sam. The catalyst, of course, will be the expectation of higher taxes. Any business that is sitting on a pile of cash and has even the slightest inkling of paying out a dividend has every incentive to do so now rather than later.

As things now stand, the tax rate on dividends is set to increase dramatically on Jan. 1, 2013. If a company is harboring a payout, it has every incentive to announce and make that payout by year-end. As a result, in the next two months the market could perhaps see a flurry of special-dividend announcements. If the dividend tax rate does increase, a dividend-paying company could hike the year-end dividend in lieu of gradual increases next year. My assumptions are purely speculative, but no one can deny that both corporations and their investors would be better served by paying dividends today rather than waiting until 2013.

Take Dell ( DELL), for example, which today trades for under $10 a share. The balance sheet reveals that the company has $7.80 in cash per share. Annual free cash flow per share, while currently in decline, is around $2 per share. Dell actually started paying its first-ever regular dividend of $0.08 a share in the third quarter.

Still, the company generates more cash than it needs. Founder and CEO Michael Dell has personally bought hundreds of millions of dollars worth of stock for himself since he reassumed his role as CEO. Shares have been trickling lower all year, and today they sit near a 52-week low of $9.80. CEO Dell would personally reap millions of dollars in tax savings from any additional dividend income. So what better way to reward shareholders, including himself, than by paying a special dividend this year?

Other cash-stuffed companies, such as Microsoft ( MSFT) and Google ( GOOG), are also ripe for a one-time special dividend. Google remains the last tech giant without any form of dividend payout, and this company certainly pulls in more cash than it needs to run and grow its business. Google insiders also own a sizeable chunk of stock, putting them first in line to benefit not only from a dividend, but from the tax savings as well.

The prospect of a special dividend is not only confined to mega-cap names. Smaller companies, which cringe at the prospect of a weaker economy or higher taxes, may find the best capital-allocation decision is to give cash back to shareholders. Look at retailer Stein Mart ( SMRT), which has a history of paying out special dividends. The stock trades for less than $8, it is debt-free and it sits on more than $2 a share in cash. In addition, insiders own nearly 40% of the shares.

Until we get closer to year-end, it will remain uncertain what form the various tax rates will take. But companies can wait until the very end to make capital budgeting decisions. Whether additional dividend payments are made is anyone's guess, but I do know that the time has never been better for companies to return cash back to shareholders.

In situations in which insiders themselves are significant shareholders, as well, you can bet that the discussion of a special dividend is not a casual one. Between now and Nov. 6, I would pay attention to companies with cash rich balance sheets and management teams that own substantial amounts of their own stock.
At the time of publication, Gad had no positions in the stocks mentioned, although positions may change at any time.

Sham Gad is the managing partner of Gad Capital Management, a value-focused investment firm based in Athens, Ga. Gad has written extensively for The Motley Fool and was a securities analyst for UAS Asset Management, a small value investment fund in New York City, in 2007. From 2002-2005, Gad managed assets for the Gad Investment Group.

Additionally, Gad has just released a new book, The Business of Value Investing: Six Essential Elements to Buying Companies Like Warren Buffett. He earned his BBA and MBA at the University of Georgia. Gad appreciates your feedback; click here to send him an email.