Special Cash Dividends Are Not So Special

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Companies with cash-rich balance sheets are cutting loose some green or accessing the debt markets, declaring one-time distributions that will be payable this month, or moving dividend dates from 2013 to the last few days in 2012. (Think Fluor (FLR)).

And, why not? The tax rate on qualified dividends that currently maxes out at 15% are likely to nearly triple for some high-income earners as we approach the fiscal cliff. If a company has ever wanted to return money to its shareholders in an effort to get on the good side of patient investors, this may be the last month in a long time when it makes sense. But does this really do anything to enhance share value? The answer is NO. What's the problem? The key word is "one-time." Paying taxes on profits is a high-quality problem. At the end of the day, investors want growth and will always pay a premium. Even with dividends, I would rather see a 2% or 3% yield that grows every two or three years that can be comfortably covered with earnings, than an 8% yield which may or may not be paid out.

Let's review a couple of names and see how this plays out. Warehouse club operator and household names Costco (COST) pays a quarterly dividend of $0.275 a share (1.1% yield). The new $7 special dividend announced last week is equal to 6+ years of the regular dividend. The company has only been paying a dividend since 2004 and still largely considered a growth play. In addition, the special payment represents most of the company's cash on hand, but management is selling new debt to cover the one-time payout.

Las Vegas Sands (LVS) cashed out some chips, declaring a special one-time dividend of $2.75 per share, which will set back the casino operator more than $2.2 billion. The company has enough cash on hand to cover the payout, but 2.5x more debt than cash on the balance sheet.

Special dividends aren't bad, but you should not base stock selection for a long-term portfolio solely on hopes that a company will return cash on a one-time basis. There is so much speculation in the market as to who is next? Could it possibly be a mega-cap tech name like an Apple (AAPL), IBM (IBM) or Microsoft (MSFT) because they are like giant bank holding companies?

A regular, steadily growing dividend rewards long-time investors for sticking around, especially in this low interest rate environment. Share buybacks cut the amount of shares outstanding, which helps boost earnings for a profitable company. But a special dividend is just a return of capital. At best, it indicates that management really doesn't know what else to do with the cash to grow their companies. At worst, it's a case of management members lining their own pockets.

So what is a good candidate for a well-rounded investment? One of my favorite core portfolio holdings is IBM. Big Blue actually has taken up its dividend 13% in 2012 and continues to use its cash to grow in key areas such as services and analytics, which is 80% of the business. Just look at how well IBM has performed relative to peer such as Dell (DELL), Intel (INTC) and Hewlett-Packard (HPQ) because it had the foresight to shift from hardware to the key area of growth. In addition, IBM increased its share buyback program in October by 75% to $11.7 billion said it plans to ask the board to authorize more in April 2013 as it seeks to improve shareholder returns.

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