Should You Buy This Huge Special Dividend?

There's nothing quite as satisfying as hearing a company you're already invested in will be distributing an outsize special dividend right into your brokerage account. Just last week, investors in retail specialist Winmark (NAS: WINA) heard that the company would be opening its coffers and offering a $5-per-share payout.

At the time of the announcement, that represented an 8.6% yield -- not the largest special payout by any means, but significant nonetheless. Since then, shares are trading up about 12% in anticipation of the payout.

This, of course, raises an important question for dividend lovers who might not already hold Winmark shares: Is it worth buying into the company after the special dividend has been announced?

A very brief history of special dividends
Typically, when an unexpected special dividend is paid out, shares are continuously bid up until investors have secured their payout... and then the bottom falls out. Investors who were already holding shares don't mind, as the price usually reverts to a price near where it was before the payout was announced.

For those who bought in because of the payout, it can mean a total wash. If you need proof, check out how Shanda Games (NAS: GAME) has done lately. On Dec. 28, the special dividend they were offering represented an eye-popping yield of 27%. Here's how shares traded between then and Friday's close.


Shanda Games Stock Chart by YCharts

But because the shareholders got their hands on the dividends yesterday, shares were trading down close to 20%.

That's not always the case, though. National Presto Industries (NYS: NPK) has been offering special dividend payouts for years now. Fellow Fool Anand Chokkavelu explains that the company adopted this stance to "keep its financial flexibility -- the better to weather tough times or fund an opportune acquisition." And the stock doesn't seem to display the same roller-coaster-esque characteristics that stocks like Shanda display.

Technology patent specialist VirnetX Holdings (ASE: VHC) also provides an interesting case study. In the past, when the company won a lawsuit against Microsoft for infringing on VirnetX's patents, the company paid a portion of those winnings over to investors. Shareholders got an 8% special dividend yield, and didn't suffer from the drop that others do.

But in the end, Winmark is no National Presto or VirnetX. Their special dividend is anything but regular (like National Presto), and it isn't the result of a sudden influx of cash (like VirnetX). Odds are likely that when investors secure the payment, prices will fall.

But that doesn't mean you shouldn't kick the tires
Before you move on to the next big yielder, however, it's important to check out the underlying company Winmark represents. If you've ever visited a Play It Again Sports, Music Go Round, Once Upon A Child, or Plato's Closet store, you've experienced what Winmark's franchisees have to offer.

The firm is soundly entrenched in what I like to call the "sharing economy." With consumers deleveraging and downshifting, these four stores actually represent quite a sound deal. Royalties paid to the company by its franchisees have grown by leaps and bounds lately -- with the majority accounted for by new openings of Plato's Closet and Once Upon A Child -- where used goods are bought, sold, and traded.

This greatly underappreciated company -- it has no analysts following it -- has grown revenue by over 10% per year over the last five years. Even more impressive, earnings per share have been growing at 40% per year over the same time frame.

The largest area of concern is the fact that CEO John Morgan, who is largely responsible for turning the company around since 2000, isn't getting any younger, and his eventual departure could leave serious question marks hanging over the company.

In the end, I'm almost fully invested, so I won't be buying shares now. But after the eventual fall of the company's shares, I'll be initiating a bullish CAPScall on my profile for the company.

And if investing in dividends is what keeps your portfolio humming, I suggest taking a look at our latest special free report on 11 rock-solid dividends. Our analysts have handpicked their favorite dividend stocks to help usher your retirement portfolio to prosperity. Get your copy today, absolutely free.

At the time thisarticle was published Fool contributor Brian Stoffel owns no shares of any of the companies mentioned. The Motley Fool owns shares of National Presto Industries and Microsoft. Motley Fool newsletter services have recommended buying shares of Microsoft. Motley Fool newsletter services have recommended creating a bull call spread position in Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.