Many investors are focused on the income-generating potential of stocks these days. With the valuation in the stock market already stretched, it has become tougher to make a case for stocks rising a lot higher from current levels in the short term.
This means that capital gains are less likely, and investors might consider focusing more on dividends as a source of returns. For these investors, special dividends offer an important source of returns.
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What Are Special Dividends?
Special dividends are extraordinary one-time dividends paid by a firm, often following quarters where profits are exceptionally high, or where a firm sells a division or otherwise raises a substantial amount of unneeded cash. Special dividends are a way of returning cash to investors directly, often in place of a share buyback.
As the name implies, special dividends are not ordinary – only a select subset of firms pay them in any given quarter.
Under ordinary circumstances, the ex-dividend date is usually set for stocks two business days before the record date – the date when you must be on the company’s books as a shareholder to receive the dividend. If you purchase a stock on its ex-dividend date or after, you will not receive the next dividend payment. Instead, the seller gets the dividend. If you purchase before the ex-dividend date, you get the dividend.
The payment date is the date when the dividend is actually paid to investors. Most of the time, the payment date is after the ex-dividend date. However, for certain special dividend cases, the order of the dates is reversed, and the payment date is before the ex-dividend date.
Two recent examples of this are Merrimack Pharmaceuticals (MACK ) and FBR & Co (FBRC). MACK paid a special dividend on May 26, 2017, but its ex-dividend date was May 30, 2017. FBRC paid a special dividend on June 1, 2017, but its ex-dividend date was June 2, 2017.
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Why Would These Firms and Others Do That?
Firms sometimes do this so that the stock’s price is not unfairly compromised. In particular, if the special dividend is a large fraction of the overall share price, then if a stock is sold to a buyer after the ex-dividend date, but before the pay date, then the seller is entitled to the dividend, but has not received it. This means the seller is in the position of having to collect the dividend from the buyer in the future.
This is dealt with through a concept called a “due bill”. A due bill is also used when the stock’s buyer is obligated to deliver a pending dividend to the stock’s seller. The due bill is essentially a promissory note. A buyer that purchases a stock ex-dividend, but prior to the dividend actually being paid, provides a due bill to the seller, showing the dividend payment belongs to the seller. On the contrary, a buyer who purchases a stock before the ex-dividend date is entitled to the dividend, but may not be listed as the owner on the record date, so the seller would receive the dividend. In this case, the seller would issue a due bill to the buyer.
For large special dividends, these issues can be avoided by having the payment occur before the ex-dividend date. This issue was especially problematic when trade settlement took a long time. Today, trade settlement of stocks is T+3, and from September 2017, it will move to T+2. This will help resolve some of the issues with due bills.
Take the FBRC example above, for instance. The firm paid a $7.61 dividend on June 1, 2017, with an ex-dividend date of June 2, 2017. The record date for the dividend was May 31, 2017, so given trade settlement times of 3 days, an investor would have needed to buy the stock by May 28 in order to be paid the dividend. In this case, though, May 28 was a Sunday, so the investor would have had to buy by Friday, May 26.
You can find out if a company has declared a special dividend by going to the dividend history section of any ticker page. For instance, you can check out the dividend history for Harvest Capital Credit Corp here.
The Bottom Line
For investors, having the payment date ahead of the ex-dividend date does not fundamentally change the economics of the dividend. The stock price is still adjusted on the payment date, and that means shareholders may be able to benefit from buying the stock ahead of the dividend, if the stock’s price does not fall by the same amount as the dividend. The cautionary note here is that investors need to be sure that they do not sell the stock until after the ex-dividend date. If they do, they might have to pay the dividend to the buyer of the security.
The lesson for investors here is to pay careful attention to dates when trying to capture special one-time dividend payments.
Click here to learn everything you need to know about special dividends. You can also see here some of the key tenets that every dividend investor should know.
