The special dividend is when the companies announce and distribute dividends in addition to the regular dividend. It’s non-recurring, and the timings of the dividend cannot be predicted in contrast to a normal dividend which is paid after the close of the accounting year (final dividend).
Effects of the special dividend on share price
Usually, the share price decreases when a special dividend is announced. In theory, it should decrease with the same amount as the amount of the special dividend.
However, it’s not the case in the real world, and sometimes a decrease in the price is the same as a special dividend or sometimes even more.
There are very rare chances of a price increase. In other words, it’s the reaction of the market that decides the impact on the price. Usually, the market does not get good signals with the announcement of the special dividend.
Background of the special dividend
The company pays the special dividend when it feels some problem in the current financing structure or just wants to reduce the excess level of the cash. Following are some of the usual reasons for a company to pay a special dividend.
- The company wants to change the capital structure. For instance, they may have greater retained earnings and want to reduce the size of the equity. Hence, payment of the dividend will reduce the size of the equity.
- The company does not have any potential opportunity to invest the funds. It may be true that external market conditions may not be feasible enough, or the company may not be making efforts to find a reasonable business opportunity.
- Anyone holding stock on the date of a declaration is entitled to receive the dividends irrespective of other circumstances.
Can we reinvest in a special dividend?
It is important to note that a special dividend is something unexpected announcement as the market does not know when the special dividend shall be announced.
Hence, it means there cannot be any plan in advance for the reinvestment of the special dividend. However, the special dividend is usually paid in the form of cash.
Hence, additional shares can be subscribed from the same company. Still, you need to assess if a special dividend should be reinvested as the following circumstances may not be appropriate for the reinvestment of a special dividend.
Circumstances when reinvestment should be avoided for the shares of the same company
Since the market may perceive the special dividend announcement as some lack on the part of the company’s management and may react negatively by selling the shares.
Further, in the following circumstance, the reinvestment in the shares does not make sense as the risk of under-performance increases. However, it’s not always the case.
- The performance of the underlying security has been poor. Reinvestment does not make sense if the security has not been performing. So, it’s time to look for other shares rather than reinvesting in the same company.
- Your age is near retirement, and you don’t want to take a risk on a steady source of income. Since the current investment has gone to be high in risk.
- You want to enhance the diversification of the portfolio by including different shares.
- You belong to a clientele of shareholders that want to get capital appreciation on their investment rather than dividends. So, you need to invest in a company that is actively expanding its scope of operations.
How it’s different from regular dividends?
The regular dividend and the special dividend differ in their meaning, timings, frequency, and nature. The regular dividend is given after regular periods. For instance, it may be paid as an interim dividend or final dividend, which is paid quarterly or yearly.
On the other hand, there is no fixed time for the payment of the special dividend, it can be paid at any time the company perceives necessary.
Further, the regular dividend is usually announced after the preparation of the financial statement. On the contrary, there is no need for any statement to announce the special dividend.
In addition to this, it has been observed that the share price increases when a regular dividend is announced while it behaves contra in the case of the special dividend. The regular dividend is some normal and recurring event, while the special dividend is non-recurring and un-predictive.
Disadvantages of a special dividend
Following are some of the disadvantages of special dividends.
- The market may perceive gaps in the company’s performance as the market can perceive that the company has nothing to do with the funds and is paying it back.
- There is an opportunity cost to make payment for the special dividends as the same amount could be invested in some projects with growth potential, which would have added value to the shareholders’ wealth.
- Usually, with an announcement of a special dividend, the company’s share price decreases. In theory, the price should decrease in line with the number of special dividends. For instance, if the special dividend announcement is announced for USD 10 per share and the current share price is USD 100. In theory, the price should be USD 90. However, the real world is much different, and the price can be 90 or 80 or even less or more; it’s on the market’s sentiments how they perceive the announcement of the special dividend.
The company can announce a special dividend at any time. Usually, the companies announce special dividends when they want to modify the company’s financing structure, got access to more cash than needed, cannot find any value-adding project, etc.
The special dividend is different from the regular dividend as there is no fixed time for the announcement.
Hence, it’s difficult to make some reinvestment plans, like a regular dividend. Although, cash proceeds from the investment can be invested in buying the security of the same company.
However, there are certain things to assess if it’s a sensible decision to invest in the company already paying back available funds to investors, probably because they think no better use than giving back.