Today, Vodafone hands almost £4 billion to its owners. What should they do with this cash?
For two reasons, today (Friday, 3 February 2012) is a very special day for the shareholders of telecoms giant Vodafone (LSE: VOD).
A dotcom mega-merger
First, Friday is the 12th anniversary of German rival Mannesmann agreeing to be bought by Vodafone in a £112 billion ($183 billion) all-share deal. At that time (February 2000), this was the largest merger in corporate history. Indeed, it catapulted Vodafone into the prized slot of being the UK's largest listed company.
Alas, this mega-merger took place right at the top of the dotcom bubble and, soon afterwards, Vodafone's inflated share price began to tumble. Twelve years on, Vodafone is merely the fourth-largest company listed on the London Stock Exchange, worth almost £87 billion as I write.
A £3.6 billion payday
The second reason for Vodafone shareholders to be pleased is that the company has dumped an extra £2 billion in cash into their laps today. This comes in the form of a special dividend of 4p per share. Given that Vodafone has over 50 billion ordinary shares in issue, this is one of the largest one-off dividends ever paid to British shareholders.
However, the cash payout to Vodafone's owners doesn't stop there. In addition, the company today paid out its usual half-yearly interim dividend, which adds an extra 3.05p per share. That's another £1.6 billion in cash flowing into the bank accounts of Vodafone shareholders this morning!
How can Vodafone afford to pay out such an enormous sum to its owners? Its ordinary dividends are well covered by its strong cash flow. However, the special dividend is a bonus coming from a £2.8 billion dividend Vodafone received on 31 January from its 45% holding in leading US mobile phone firm Verizon Wireless.
Thanks to this special dividend, Vodafone will overtake oil behemoth Royal Dutch Shell (LSE: RDSB) to become the UK's biggest dividend payer in 2012.
What to do with this windfall?
Of course, being one of the FTSE 100's mega-cap firms, Vodafone's shares are very widely held, both by professional fund managers and private investors. Hence, this £3.6 billion cash payout will be shared by millions of British and foreign investors.
Therefore, the big question is: what should shareholders do with this bumper bounty? Here are six ideas to get you started:
1. Pay off debts
Although the Bank of England's base rate has been firmly stuck at 0.5% since March 2009, credit and store cards have been getting increasingly expensive. Indeed, a typical credit card now charges interest of over 19% APR, which comes to almost 1.5% a month.
Therefore, if you've been landed with a bumper Christmas credit-card bill, then it makes sense to use any spare cash to repay this debt as quickly as possible.
2. Reduce your mortgage
Just as savings rates have plunged since the financial crisis, so too have mortgage rates.
Even so, it still possible to earn a decent -- and guaranteed -- return by using spare cash to reduce the size of your home loan. For example, a higher-rate (40%) taxpayer with a mortgage costing 3% a year would need to earn 5% from a taxed savings account to beat the return on offer by paying off part of his home loan.
3. Strengthen your savings safety-net
If you have little or no debt, but have less than, say, three to six months of living expenses in cash, then you could beef up your savings. With a Best Buy cash ISA, you could earn interest of over 3% a year, with no tax to pay.
4. Buy more Vodafone shares
Of course, you could use this cash payout from Vodafone to buy more of its shares. Like many major companies, Vodafone operates a DRIP -- a Dividend Reinvestment Plan -- that allows shareholders to take their dividends in shares, rather than cash.
Through this scheme, Vodafone uses the cash from dividends to buy more shares in the open market for DRIP investors. This service costs 0.5% of the total value of your dividend payment (no minimum charge), with a further 0.5% paid in stamp duty reserve tax. Having joined the DRIP, future dividends will continue to be reinvested until you inform the DRIP administrator.
5. Buy more dividends
If you're a keen dividend-seeker, then there are plenty of other mega-cap companies offering generous dividends to patient shareholders. Indeed, in a quick search of the blue-chip FTSE 100 index of Britain's corporate elite, I found 14 other major corporations with yearly dividend yields of 5% or more. Thus, instead of adding more Vodafone shares, you can use your cash windfall to buy other high-yielding shares.
6. Dodge tax
Last but not least, this cash windfall may also land you with a tax problem.
For basic-rate (20%) taxpayers, there is no extra tax to pay on dividends paid by directly held shares, thanks to a notional 10% tax credit. However, higher-rate taxpayers lose a quarter (25%) of their net dividends (22.5% of the gross dividend) in additional tax.
Therefore, if you'll be forced to pay tax on this Vodafone hand-out, then learn your lesson now. Instead of holding dividend-paying shares directly, put them inside a tax-free shelter such as an ISA or SIPP. By doing this, future dividends will be entirely free of tax, and will no longer have to be declared on your tax return.
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