Special Dividends Unlock Hidden Value In Stocks

Most investors view stocks as lottery tickets - they buy and hope for the greater fool theory to kick in order to sell at a profit. More often than not however these investors lose a lot of money in the stock market, as they never seem to learn that stocks represent small portions of a business, which sells products or services and hopefully earns a decent profit while building on to its asset base.

Many investors have taken a beating recently, especially as the recession and bear market kicked in earlier in 2008. Some are bailing out of stocks completely, while seeking the relative safety of Treasury Bonds or Certificates of Deposit. Some investors however have seen the current bear market as an opportunity to load up on cheap stocks, which are trading below the net levels of cash on their balance sheets. The net-net strategy was popularized by Ben Graham who bought stocks after the Great Depression at steep discounts to the net asset values per shares realizing huge profits in the process.

Imagine a company ABC that has 1 million shares issued and outstanding trading at $0.50/share, has zero debt and no liabilities, and also has $1 million in cash and equivalents on its balance sheet. Now further imagine that the company is at least breaking even in terms of earnings. Would you pay $0.50/share for an asset that has a value of at least $1.00?

Now the answer is not as straightforward since one needs to determine what catalyst would bring the price closer to $1.00. If the company decides to spend the cash on an ill-fated venture, then the value of the stock would drop. However if the company decides to liquidate or pay a special dividend to shareholders, then the stock should be worth more than $0.50/share.

Most recently I have seen several small cap companies announcing a special dividend:

Back on March 16, FortuNet (FNET) announced that it would ask shareholders to approve a special $2.50 cash dividend on its April 17 meeting. As a result the stock price rallied 75.2% in a single day to $2.40/share. FNET earned $0.25/share in 2008 and has almost $2.75/share in total cash and investment securities as of 12/31/2008.

Back on December 5 Eden bioscience (EDEN) announced it would be winding down its operations. The stock rallied 77% on the news. The company had $1.80/share in cash. A potential issue is that winding down operations could cost money.

A company I am currently looking at from a value-investing standpoint is TheStreet.com (TSCM). Currently the online stock market content provider has $72.4 million in its coffers, versus total liabilities of $19 million, for a net $53.4 million or $1.76/share in cash. I like the fact that TSCM is paying out a quarterly dividend of $0.025/share. I would be interested in TSCM on dips below $1.50.

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