2010 may be the last year to have dividends taxed at 15%, and companies are responding by handing out special dividends. So far this year, Garmin (NASDAQ: GRMN), Transocean (NYSE: RIG), Hot Topic (NASDAQ: HOTT), Guess (NYSE: GES), etc. have already declared special dividends.
With only one month left for 2010, the pace of announcing special dividends seems to be accelerating. In this week alone, we see OptionsXpress (NASDAQ: OPXS), White River Capital (NYSE: RVR), and Interactive Brokers (NASDAQ: IBKR) declared special dividends, ranging from 10%-26% of their stock prices before the announcements.
Typically companies who declare special dividends have the following characteristics:
- Strong insider ownership
- Healthy cash flow
- Cash heavy balance sheet
To pay for the special dividends, most companies dip into their cash balance. However, in such a low-interest rate environment, some companies choose to issue short-term notes to pay for it. Investors in these companies have to be careful if the companies borrow too much just to pay the dividend, because they are essentially betting on a healthy operating environment so they can repay the debt later.
These special dividends situations also make it quite tricky for short sellers, because a large special dividend can push up the stock prices quite a bit, not to mention the short sellers will have to pay the dividends to the rightful owners of the stocks they borrowed from when time comes.
For investors who want to capture the special dividends, they have to remember that the stocks will trade ex-dividend by adjusting the stock price downward afterwards, and options will be adjusted as well. Don’t rush out and buy a stock with large special dividend thinking it’ll be a free ride to profits. The trade could make sense, however, if an investor could use any loss after the sales of the stocks to offset other capital gains. There are many tax rules governing dividends related trading, so make sure to check with a knowledgeable accountant before making any moves.
This article originally appears on benzinga.com