There are three unintended consequences on dividend stocks and dividend investors being caused by the uncertainty of 2013 tax rates. The consequences are an extraordinarily large number of special dividend declarations, the early payment of typical first-quarter dividends and the future adverse impact on dividend growth rates for certain companies. These unintended consequences are a subject we are discussing in the December AAII Dividend Investing monthly report, and I'll share an overview about them here.
Howard Silverblatt, the senior index analyst at S&P Dow Jones Indices, counted special dividend (extraordinary distributions that will not be repeated in the future) declarations from 228 companies occurring last month. To put this number in perspective, total annual (not monthly, but annual) special dividend declarations have averaged 181 over the past eight years. Only 2007 saw more declarations than November 2012 (233 for all of 2007 versus 228 for November 2012).
Whether paying a special dividend is a good thing is debatable. If a company truly has excess cash on its balance sheet that is not needed to fund future profitable projects, then distributing it to shareholders is the right thing to do. AAII Dividend Investing holding Waddell & Reed Financial (NYSE:WDR) is a company that is using its cash balance to fund a special dividend.
Conversely, Costco (NASDAQ:COST), a stock we do not hold, issued $3.5 billion in new debt to pay a special dividend of $7.00 per share. Selling bonds to pay for a dividend is akin to cashing one of those credit card checks sent in the mail so you can have an expensive night out on the town. Well after the joy of the night is gone, the repayment obligation lingers.
Some companies are paying their typical first-quarter dividends before December 31, 2012, to take advantage of known tax rates. For individual investors holding these stocks (or those of companies issuing special dividends), reported gross income for 2012 will rise. Consult a tax professional if you have questions about the implications on your tax liability.
The acceleration of payment dates also impacts future dividend growth rates. By shifting a 2013 dividend payment into 2012, a company risks having databases lower its annualized dividend growth rate for years to come. Here's why. Assume a company paid a quarterly dividend payment of $0.20 per share in 2012. In November, the company raised its 2013 quarterly dividend payment to $0.22 per share (a 10% increase), but shifted its typical January payment to the end of December 2012. The calculations will show $1.02 in dividends paid in 2012 (four payments of $0.20 per share and one payment of $0.22 per share) and $0.66 in dividends paid in 2013 (three payments of $0.22 per share), a 35% decline in the annual dividend growth rate.
The figures displayed on many websites and used in stock screens will be calculated using the larger cumulative dividend payments in 2012 and the smaller cumulative dividend payments in 2013. This is because the databases are not programmed to consider temporary, tax-related actions. Expect to see the annualized dividend growth rates for those companies that are paying their typical first-quarter 2013 dividend before the end of 2012 reduced, or even negative, for years to come. Also expect these companies to be excluded from stock screens that require either consecutive annual dividend increases or a minimum dividend growth rate. (The database used for our stock screens and our Stock Investor Pro screening software does not factor special dividends into the dividend growth rate calculations. I cannot say with certainty how other databases treat special dividends.)
Disclosure: I am long WDR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: WDR is held in the AAII Dividend Investing tracking portfolio.