On the face of it, this is encouraging. It suggests companies are not hoarding cash, as they did when capital markets were tighter a few years ago. A management team must be genuinely confident in both a company's funding position and its ability to continue generating cash if it returns its bank balance to shareholders. For investors, special dividends, like regular dividends, are also appealing as returns in the hand rather than the bush. It is worth repeating that 87 per cent of UK shareholders' returns since 1900 have come from dividends.
But there is also a darker side to special payouts. For a start, they create more work for investors, who need to redeploy the cash. You can just use the money to buy more shares in the same cash-rich company, but this seems odd: why in effect give more funds to a management team that is making clear it does not need it?
This is the key problem with special dividends: they can signal a lack of growth opportunities. If management saw underserved markets, they would use the cash to expand their services. Likewise, if they saw companies or assets at reasonable prices, they would buy them. Giving the capital back to shareholders implies saturated markets and overpriced competitors - hardly a backdrop against which investors might expect to find value.
The insurance sector is the clearest case in point. Lloyd's of London stalwarts Brit (BRIT), Amlin (AML), Hiscox (HSX) and Lancashire (LRE) have all posted big special dividends over the past few weeks. They make no secret of their reasoning. A quiet couple of years for hurricanes has left insurers overstocked with capital. Moreover, the hunt for yield among institutional investors has drawn alternative sources of finance into insurance through funds. The combination has intensified competition, forcing underwriters that want to preserve their margins to withdraw into more specialist areas.
Some companies have used spare cash for acquisitions - although the London exchange has fielded targets rather than bidders, with both Brit and Catlin (CGL) set to be absorbed by North American rivals. But underwriting is a people business, so mergers always come with the risk that key personalities clash and leave. Understandably, the UK players have decided it is easier to return cash to shareholders than play that game.
Another sector currently sporting special dividends galore is housebuilding. But the situation here is rather different. If there is one thing economists, pundits and politicians agree on, it is that the UK needs more homes. The special dividends from housebuilders - Taylor Wimpey (TW.), Persimmon (PSN) and Barratt (BDEV) all announced or reiterated special payouts alongside their recent results - are not the result of overcapacity, but rather the fruits of undercapacity for those lucky enough to be in the business.
So why don't these companies use their spare cash to accelerate production in a supply-constrained market - as basic economics would suggest they would? One reason is their artisanal approach, reliant on bricklayers and carpenters rather than factories. Upping production is not simply a matter of using cash flow to buy a new machine. Another reason is historical: most housebuilders took on too much debt in the years before the financial crisis, only to beg shareholders for capital when the cycle turned. They are trying to rebuild their reputations, and pledges to return capital bespeak discipline. This is particularly important given the infamous cyclicality of UK housing. Nobody wants to be caught with aggressive expansion plans the next time homebuyers run for the hills.
This post-crisis fear of the cycle also explains special dividends beyond the housebuilding sector. Engineers are fond of boosting rather modest regular dividends with special payouts: Synthomer (SYNT), Bodycote (BOY) and Elementis (ELM) are recent examples. These companies know they operate in cyclical markets, and don't want to be caught out raising income expectations in good times only to have to hack them back later. The same goes for advertising-dependent broadcaster ITV (ITV), which has paid special dividends for the past three years, and London estate agent Foxtons (FOXT).
Special dividends betray a certain confidence on the part of management teams - but also a reluctance either to splash cash on big projects or to bet that strong cash generation will continue indefinitely. So enjoy the windfalls, but remember they are as much a sign of caution as of optimism.
