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  1. Home
  2. / Investing

Why More Companies Might Issue 'Special Dividends' Soon

Firms flush with cash from the new U.S. tax cuts could make one-time payments to shareholders.
By CHRIS VERSACE
May 05, 2018 | 12:00 PM EDT
Stocks quotes in this article: MSFT, PCAR, URI, AAPL, BBT

Companies ranging from Microsoft (MSFT) to heavy-truck maker Paccar (PCAR) have over the years declared so-called "special dividends" -- one- time extra payments to shareholders. With the new U.S. tax law granting corporations a limited window to repatriate overseas profits at low tax rates, many companies might use the extra cash for special dividends. Let's discuss how this impacts income investors.

More than 1,800 companies have reported or will report their quarterly results within the next few days as part of earnings season. Contained in management's comments about different business lines and industry developments, some companies will talk about "cash flow" and "returning capital to shareholders."

For those unfamiliar with cash flow, that's the net amount of cash and cash- equivalents that are being transferred into and out of a business. Some businesses require additional outside cash to stay in business, while others generate extra cash that a company can reinvest in the business or book as profits.

And then there's free cash flow, which is the cash that a company generates after spending the money required to maintain or expand its asset base. Think of free cash flow like disposable income, the amount of money you have left at the end of the month after you've paid all of your bills.

Just as a person can save disposable income or spend it, a company can use its free cash flow to invest in the business, boost its cash reserves or return capital to shareholders via either share buybacks or dividends.

Free cash flow will be particularly important this earnings season because of the new U.S. tax law passed in late 2017. Companies have been taking the past several months to study the new law, but investors expect to hear about the beginnings of its impact during the current earnings season.

For instance, rental-equipment company United Rentals (URI) shared the following during its recent earnings conference call: "Tax reform benefited us something like $0.50 over last year. ... So, $0.50 out of the $1.24 [per share] or so that we improved year over year we could put down to tax reform."

As President Donald Trump would say, that's a "yuge" amount! It's true that United Rentals derives nearly all of its operating profits from inside the United States, but odds are that other companies will see positive impacts on their bottom lines as well.

The thing that investors and analysts are trying to wrap their arms around now is to what degree bottom lines will benefit. They're working hard to determine the new tax law's impact on companies cash flows and free cash flows. After all, lower taxes generally mean more cash that a company can use to invest, save or return to shareholders.

Consider Apple (AAPL) which has billions of dollars in overseas cash that it might now look to bring home. There's a growing consensus that AAPL will use the benefits of tax reform to fund significant increases in share repurchases and cash dividends. Citi Research recently estimated that Apple could raise its capital- return program to about $400 billion from the current $300 billion through a combination of dividend hikes and larger share repurchases.

That's another potential "yuge" increase, but odds are that Apple won't be the only company to announce a more-robust capital-return program. However, as I wrote a few weeks ago, investors expect any dividend hike to continue in perpetuity. Heaven help the share price of a company that doesn't keep the quarterly payouts coming.

This puts a company in a precarious position. The U.S. tax cuts aren't permanent, but investors expect any dividend boosts related to the program to be.

Enter the special dividend. BB&T Corp. (BBT) announced plans in February to use a portion of its corporate-tax savings to pay a special dividend of 4.5 cents per share in addition to its regular 33-cent-per-share payout. This elegant solution allows companies to return excess cash to shareholders, but doesn't trap managements with expectations for a recurring quarterly payout.

I suspect BB&T won't be the only company to use this capital-return strategy in 2018. On the contrary, we're likely to hear many more companies talk about special dividends in the near-term.

This article was originally sent to subscribers of TheStreet's Income Seeker, a product presenting the world of opportunities in fixed income and dividend stocks. Click here to learn more about Income Seeker and to receive articles like this from Chris Versace, Robert Powell, Peter Tchir and others.

Paccar and United Rentals are positions in the TheStreet's Trifecta Stocks portfolio. Click here to learn more about this portfolio, trading ideas and market commentary product.

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At the time of publication, Versace had no positions in any securities mentioned.

TAGS: Investing | U.S. Equity | Dividends | How-to

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