What it is:
A special dividend, also known as an extra dividend, is a one-time distribution of corporate earnings to company shareholders, which usually stem from exceptional profits during a given quarter or period.
How it works (Example):
Special dividends are typically disbursed in cash and tend to be a greater amount than the company’s standard dividend payment. The extra payment is a way for the company to share its profit "windfall" with shareholders.
Special dividends are also a way for a company to demonstrate good faith with its shareholders. A special dividend serve as a reward to shareholders designed to engender loyalty.
Special dividends may also serve goals other than sharing the good fortune with investors. They can be used to display to the rest of the market that the company's long-term footing is sound. The decision to distribute special dividends can also be used to further the strategic interests of management.
For example, a company can issue special dividends if it decides to change its capital structure, i.e. the percentage of debt vs. the percentage of equity used to finance the company. By decreasing its assets (because dividends are paid out of cash) the firm's debt ratio will increase.
Why it Matters:
Regardless of whether an investor is interested in income-producing holdings, dividends play an important role in the overall performance of any portfolio. And when an investor is seeking stock to hold for the long-term, a company's record of paying special dividends often signals that it is focused on stability, long-term prospects and steady management.
Investors specifically interested in companies that show consistency in raising dividends every year should check out a special group of companies called "dividend aristocrats" and "dividend achievers."