Why special dividends are set to become more popular

Updated: 
Pile of pound coins

Special dividends are, by their very nature, somewhat unusual. They are not generally paid on a regular basis and have historically represented an exceptional payment by a company to its shareholders which is not expected to continue in the long run. This could be due to an asset disposal or a particularly strong year for the business, for example.

However, with the global economic outlook becoming increasingly uncertain and inflation having the potential to move higher, special dividends could become increasingly commonplace. This, though, may not necessarily be good news for Foolish investors.

A changing outlook

The global economic outlook is highly fluid and uncertain at the present time. Brexit has the potential to cause challenges in the Eurozone, while anticipated higher spending in the US may not meet expectations due to political difficulties. Although Chinese growth has stabilised somewhat, its transition from a capital expenditure-led economy towards a consumer-focused economy is unlikely to be frictionless.

The effect of this uncertainty on companies across the globe could be a desire for greater financial flexibility. Although their profits may be moving higher, businesses may be uneasy about rewarding their shareholders through higher ordinary dividends. That's because there is an expectation that ordinary dividends will be maintained or even increased on an annual basis.

Therefore, special dividends may allow company management to reward their investors, but do so on a basis which does not put them under pressure to continue dividend payments should their financial performance worsen. As such, special dividends may become more commonplace. They could even replace share buyback programmes, as investors seek a higher income return as the world economy enters a period of potentially higher levels of inflation than it has experienced in the recent past.

A changing policy

While higher special dividends may seem like good news for Foolish investors, that may not necessarily be the case. Company management may increase special dividends, but at the same time slow down the rate of growth in ordinary dividends. This could easily be justified with reference to an uncertain outlook and could provide even greater financial flexibility when it is needed most.

However, it could also mean that investors do not receive an income which is higher than it otherwise would have been had special dividends not been paid. In other words, money which would normally have been paid via an ordinary dividend may instead be paid through a special dividend which is more likely to be cut or even disappear in future. As such, the overall income appeal of companies may change, but not drastically improve.

Takeaway

While special dividends may become more popular due to an uncertain economic outlook, it may be a case of 'giving with one hand, and taking away with the other' for cash-strapped companies. Still, with inflation potentially moving higher, buying high-quality dividend stocks could still be a shrewd move for Foolish investors in the long run.

With that in mind, the analysts at The Motley Fool have written a free and without obligation guide called Five Shares You Can Retire On.

The five companies in question offer stunning dividend yields, have fantastic long term potential, and trade at very appealing valuations. As such, they could improve your income returns in 2017 and beyond.

Click here to find out all about them - it's completely free and without obligation to do so.