Goldman: A Special Opportunity for Special Dividends
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The Fiscal Times
September 25, 2012

In the volatile and uncertain market environment we've been mired in for much of the post-crisis period, one of the favorite strategies of veteran investors has boiled down to the simple strategy of buying stocks that pay above-average dividends and – even better – those that have a track record of increasing those payouts at regular intervals.

The equity research team at Goldman Sachs now is advocating a twist on that idea, especially designed to appeal to investors as we head into the final quarter of the year. Their research tells them that it’s during this final three-month period that nearly half of all special dividend announcements are concentrated – and that over the last dozen years, 75 percent of the companies that announced such special dividends outperformed the S&P 500 not only immediately after the announcement but as long as two months later.

A couple of factors make this particularly interesting in 2012. The first is the pesky "fiscal cliff," or rather, the uncertainty surrounding what kind of tax rate investors will find themselves paying on their dividend income in 2013. Will it be the 15 percent that currently prevails or will it be as much as 43.4 percent (if dividends get taxed as ordinary income, with a top tax rate that might revert to 39.6 percent, plus a new 3.8 percent tax for high-earners)? Or will it be another rate somewhere in between? 

In light of the uncertainty, the argument by the Goldman Sachs team is that corporations pondering a special dividend might want to do so pronto, in order to give their investors the benefit of a lower tax rate. That’s logical, as is the fact that many companies sitting atop mountains of cash might want to avert shareholder ire by finding a way to hand it back to those shareholders via, oh, let’s say, a special dividend payment. Corporate cash balances are up 55 percent in the last five years, and the ratio of cash to enterprise value among the companies Goldman Sachs covers has jumped to more than 9 percent from 6 percent. 

The logic is impeccable, and special dividends have indeed become another reason for investors to celebrate the concept of "yield" – the first nine months of the year mark the greatest level of generosity on the part of corporate treasurers since 2000, and Goldman Sachs believes 2012 could end up posting a record when it comes to special dividends. But the list of stocks that their research team has assembled for your consideration is, well, a bit of a motley assortment.

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The Goldman Sachs screen did look for limited leverage and a healthy amount of liquidity – both desirable characteristics. Of the 13 companies that popped up on their final list (and two others added by the research team), four are asset managers, like hedge fund group Ochs-Ziff Capital Management (OZM) and the relatively small Pzena Investment Management (PZN). That's a lot of concentration in one segment of the market, given that hedge fund performance is underwhelming and investors have been dumping mutual funds in favor of ETFs of late. 

Another stock on Goldman’s list, Williams Sonoma (WSM), is a retailer; there are also three gaming and leisure stocks and a couple of health-care companies. One of the 15 companies, aviation parts supplier TransDigm Group (TDG), doesn't even pay a regular dividend as yet – although it trades at a valuation approaching twice that of the S&P 500, or 25.91 times trailing earnings. Current yields on the stocks in Goldman’s group range from zero for TransDigm and 0.26 percent for Mastercard all the way up to 5.77 percent for Ochs-Ziff.


Potential Special Dividend Candidates

Company Ticker
Federated Investors, Inc. FII
Franklin Resources, Inc. BEN
General Dynamics Corp. GD
Interval Leisure Group, Inc. IILG
Las Vegas Sands Corp. LVS
Mastercard Inc. MA
Molex Inc. MOLX
Och-Ziff Capital Management Group OZM
Patterson Companies, Inc. PDCO
Pzena Investment Management, Inc. PZN
Stryker Corp. SYK
TransDigm Group Inc. TDG
Western Refining, Inc. WNR
Williams-Sonoma, Inc. WSM
Wynn Resorts, Limited WYNN
Source: Goldman Sachs

This list has the aura of being an assortment of stocks that might be suitable candidates for active traders – market players who can afford to establish a position in a dozen or more stocks for the next few months and then sell them if nothing materializes, or after having captured any post-special dividend runup. 

That’s not to say that some of these stocks might not be good long-term investment ideas as well, but the odds of enough of them working out and for the average investor to be able to jump in and out in a timely fashion don’t seem to be all that impressive. Essentially, what Goldman Sachs is suggesting is that by taking a position today, waiting for the bounce following an announcement in a certain percentage of them, and then selling, the outperformance even after transaction costs will be impressive enough to offset the risk. That may be true for Goldman's typical client. But even members of that group have shown, time and again, that they fail to act promptly enough or hang around too long after recording a big gain.

Here’s a thought. Take this list and evaluate the companies on it more deeply. They have been generating cash flow and have cash on their books, which is great – but are their earnings growing and of good quality? Are these companies that you would want to own anyway? Most importantly, in addition to any one-time benefit from a special dividend, are they likely to be raising their regular dividend payout any time soon? What are their valuations, relative to those dividend yields? If those questions produce satisfactory responses, then it’s perfectly reasonable to ponder adding them to your portfolio. But as investments, not trading ideas.

Business journalist Suzanne McGee spent more than 13 years at The Wall Street Journal before turning to freelance writing. Author of the book Chasing Goldman Sachs, she has written for Barron’s, The Financial Times, and Institutional Investor.