A number of years ago, I was an adviser to a smallish, publicly-traded bank holding company. Because of past anemic dividends, this bank had accumulated several millions dollars of excess capital. The stock was very thinly traded and the market price was quite low, reflecting a very low Return on Equity (ROE).
Because of the very thin market for shares, a stock repurchase was not considered workable. After some analysis, I recommended that the board of directors approve a large, one-time special dividend. At the same time, I suggested they approve a small increase in the ongoing quarterly dividend. Both of these recommendations provided shareholders with liquidity and the opportunity to diversify their holdings.
Since the board of directors collectively held a large portion of the bank’s stock, the discussion of liquidity and diversification opportunities – while maintaining their relative ownership positions in the bank – was attractive.
At the final board meeting before the transaction, one of the directors did a little math. He noted that if they paid out a large special dividend, the bank would lose earnings on the assets and overall and earnings would decline. I agreed with his math (the calculations were certainly in the board’s package!), but pointed out that the assets being liquidated had very low yields and that earnings (and earnings per share) would not decline much. With equity being reduced by a larger percentage, the bank’s ROE would increase. So that increase in ROE, given a steady price/earnings multiple in the marketplace, should increase the bank’s price/book value multiple.
The director put me on the spot. He asked, point blank: “What will happen to the stock price?” I told him that I didn’t know for sure – does one ever? – but that the price should increase somewhat and, if market participants believed that they would operate similarly in the future, it could increase a good bit. The stock price increased more than 20% following the special dividend.
Special dividends, to the extent that your company has excess assets, can enhance personal liquidity and diversification. They can help increase ongoing shareholder returns. I have always been against retaining significant excess assets on company balance sheets because of their negative effect on shareholder returns and their adverse psychological impact. It is too easy for management to get “comfortable” with a bloated balance sheet.
If your business has excess assets, consider paying a special dividend. Your shareholders will appreciate it. The returns for all shareholders will increase. Your balance sheet will be in better condition and ready for unexpected opportunities. And you may focus on management just a bit more if you take away the “cushion” of excess assets.
Questions: Do you have excess assets on your balance sheet? If so, why? If you have clients who have excess assets, have you asked them why?