Costco’s Special Dividend and Market Irrationality

On December 14th, 2023, Costco announced a special cash dividend of $15 per share. With about $18 billion in cash on their Balance Sheet, they simply had too much cash, and the board of directors decided to give some of it back to shareholders. This is above their usual quarterly dividend that has amounted to a return of about 3 percent per year.

For shareholders, this bonus cash is not an unalloyed joy if they would rather not receive the cash and have to pay taxes on this income. But let’s assume that most COST shares are owned in tax-protected retirement accounts and university endowments.

Not surprisingly, on this happy announcement, Costco shares jumped up in price. They had been trading at around $630 per share. How much should they have jumped? As the special dividend is a one-time event, the shares should have risen to about $645 (assuming Costco is still left with abundant cash to run the business.) The share price actually rose to over $675 i.e. $45 up in anticipation of $15 of free money. The only way to justify this would be to assume that Costco is going to give shareholders a $15 Christmas gift, beyond regular dividends, in perpetuity.

Experienced investors would’ve paid attention to two dates in the dividend news release: The “record date” and the “payable” date. The special dividend will be paid out to shareholders on 12 January 2024, but it is paid to people who owned the shares (“on the books”) at the close of business on December 28th, 2023.

If the market is rational, from 12/28 to 12/29, the shares should have dropped by $15 as people who buy after the Record Date won’t get the extra cash, even if they do own the shares on the payable date in January.

In fact, the shares dropped from $663 to $659 – the price is still way too high. I can only assume that the Robinhood crowd is buying into the stock after the Record Date still falsely imagining that they are going to reap the extra $15.

Why I Don’t Believe in Analysts, the Tooth Fairy or Santa Claus

I have never put much faith in financial “analysts” – while they may appear to have sophisticated models that allow them to predict the future, those models depend on so many assumptions (e.g. how much the US economy is going to grow) and can’t model in event risk (e.g. war breaks out with Iran, Biden is impeached) that I have always taught my students that their guess as to a stock price 12-months from now is likely to be as good as a professional analyst.

If you look up the 12-month target price for COST, there are no fewer than 27 professional analysts who are covering the stock. Bear in mind that at the close of 2023, the shares are changing hands at about $660. The December, 2024, median price target is $670, not much up. The range of estimates are from $502 at the low end to $745 at the high end. Pick a number.

The Market is Rational – in the Long Term

I anticipate that the price of COST will drift lower by mid-February, after the game-playing dividend hunters have found out that they missed the Record Date. I sold my long-held position in COST after the record date – I’ll still get the dividend – as I concluded that the Market was bidding the shares irrationally high. I love the company and it’s been a very good investment for me, so I’ll buy the same position when the price fades in a month or two. I firmly believe that in the long term, the Market is rational and share prices are sensible. But there’s a lot of silly irrational behavior in the short term.