Enterprises that are well-established may provide dividends to attract investors, but young or struggling companies may also utilize dividends as a way of attracting new customers. One of the most common types of value traps (also known as a dividend trap) arises when investors are enticed by a high dividend yield, only to discover that they were wrong.
Are dividend stocks a trap?
As an income-seeking investor, you should choose dividend stocks, but only if the dividends are reliable and sustainable. The term “yield trap” refers to a stock with a high dividend yield but a questionable business model. The REIT stock investment itself could lose a large amount of value if the business isn’t performing successfully.
Real estate investment trusts, or REITs, are no exception when it comes to yield traps on the stock market. We’ve outlined some of the obvious markers to look out for, as well as three examples of REITs that have them.
What is the yield trap?
More than half of the profits from Australian stock investments in the past decade came from dividends, and dividend payers are a clearer path to long-term gains.
As a result, dividend-paying corporations make a compelling case for investment. Isn’t it logical to stock your portfolio with high-yielding stocks?
Even if dividends are beneficial, it doesn’t follow that higher dividend yields are better, a Morningstar analyst writes. As a result, “such a strategy does not screen out the low-quality, hazardous corporations that are likely to lower their dividends in the future, or possibly file for bankruptcy.”
Using dividend yield as a valuation metric might be risky. Companies with high dividend yields may appear to be bargains, but they may be overpriced and untrustworthy.
Such companies may be experiencing financial difficulties that have resulted in a drop in their stock price (and the yield to rise). To conserve money, corporations may have to reduce their dividends, thus the dividend yield they’re now reporting may be lower than it actually is.
Investors are enticed by the prospect of a large dividend yield and favorable tax advantages, which is where the “trap” comes into play. As a result, its income and share price plummet as the company’s fundamentals are found to be fragile.
Telstra is a good example of this, as are many Morningstar readers. Since the middle of 2015, the stock price of Telstra has been declining.
As long as the company maintained its attractive fully-franked dividend, investors were willing to overlook the company’s poor stock price performance. During the stock market’s decline, the dividend yield increased, reaching a peak of nearly 9% in November 2017.
Telstra was compelled to reduce its dividend from 30.5 cents per share in fiscal-2015 to 16 cents per share in fiscal-2019 in order to preserve its balance sheet strength and operational flexibility.
Pact Group Holdings, a packaging company, is another notable example. The company’s dividend yield hit a five-year high of 6.71 percent in November 2018 when the stock price fell below $3.50, according to the company’s quarterly report.
Since fiscal 2014, Pact’s dividend has increased gradually, from 9.4 cents per share to 23 cents per share by the end of fiscal 2018. However, Pact’s stock price plummeted in fiscal 2019 as the company announced a decline in profitability. Dividend payments were halted.
Are dividend stocks safe?
A safe and reliable investment, dividend stocks are well-known. There are a lot of high-value enterprises here. Safety is generally associated with corporations that have raised their dividends year after year for the past 25 years or more, known as the “dividend aristocrats.”
Why are high dividend stocks risky?
- It’s possible that a company in trouble has a high dividend yield. Because the business’s shares have plummeted in reaction to financial difficulties, and because the troubled company hasn’t yet decreased its dividend, the yield could be high.
- A company’s ability to consistently pay out dividends should be examined by investors, which includes looking at its free cash flow, historical dividend payout ratio, and other financial measures.
- A rise in interest rates puts a strain on stocks paying dividends. Compared to the risk-free rate of return offered by government securities, dividends lose their appeal.
How do you find a dividend trap?
A dividend trap is a corporation that pays out a high dividend – at least 5% – that you can imagine retiring on. An underperforming business model and incompetent management are behind the company’s high dividend yield, which comes at a high price.
How high of a dividend is too high?
As a final step, have a look at the dividend payout ratio, which shows how much money is going to shareholders. Overly high payout ratios — often above 80%, though this varies by industry — indicate that a significant portion of a company’s earnings are dedicated to dividend payments. This means that the corporation may be going into debt in order to pay out dividends in some situations. ( Take a look at our detailed instructions on
Is it better to have a high dividend yield?
The higher the dividend yield, the larger the risk, but the higher the dividend yield, the greater the income. Even though lower-yielding dividend stocks provide a lower income, they are frequently offered by more reliable corporations with a long history of continuous growth and consistent dividend payments.
Is a 10% yield good?
To make your buy-to-let home profitable, you need to figure out how much you should charge for rent. This is something that every property investor will tell you.
You can find out how much rent is being charged for similar properties in the area by using a property website. In other words, if you’ve narrowed down your shortlist of properties by charging exorbitant rents in order to earn a profit, you may want to reconsider.
So, how do you know what a good rental yield is? For all your property investment questions, we’re here to help.
What is a rental yield?
You might think of a rental yield as the annualized value of the rent that you can expect to earn from your property. By dividing annual rent by your initial investment, you get the rental yield %.
How to work out rental yield?
Divide the annual rental revenue by the property’s price and multiply the result by 100 to arrive at the yield on a rental property.
So, if you bought a property for £200,000 and charge a rent of £10,000 each year, you’d have a 5-percent rental yield.
Our online rental yield calculator is a far more convenient method of calculating rental yield.
What is a good rental yield?
Your rental income must meet the property’s operating costs. Assuming you’d otherwise have to pay for wear and tear and other lettings-related expenses, this includes your mortgage. A contingency fund may have to be used more frequently if you don’t plan for this.
What is considered a decent return? Property investors that know what they’re doing tend to strive for rental yields of 5% to 8%. A respectable return on your investment should be possible with this amount of money.
What are the average rental yields in the UK?
The yields differ from one region to the next. Nottingham currently has the UK’s highest rental returns, at up to 12 percent on average. On the other hand, university cities like Brighton, England, give the best investment returns. As of 2018, the average rental return in Brighton was considerably above 5%. Brighton was one of the most profitable places to own property in Sussex in 2018.
So, what is it about college towns that makes them so attractive to landlords? There is only one solution: student housing.
Are student lettings a good investment?
The best rental yields come from renting to students, but if you are looking for a long-term investment, you might want to consider other choices.
If you’re planning on renting out a student residence, you’ll need to account for letting fees, advertising costs, and possible void periods while making your investment decision.
You may also have to spend more money on repairs because a young student is less likely to take care of your property as a long-term tenant would. Consider the impact on your resale value – how much will you have to spend on renovations to get the price you want?
Recap: What’s a good rental yield?
- Divide your annual rental revenue by the total amount of your investment to arrive at your rental yield, or use a yield calculator.
- While student rentals may produce the highest rental income, they also come with a slew of additional expenses.
Can dividend yield be too high?
In many cases, a high yield cannot be maintained for an extended period of time. As a dividend stock investor, you want yields that are long-term and sustainable. For this reason, companies with the highest yields are the most inclined to reduce them.
Do dividends go down when stock price goes down?
As a last long-winded explanation, dividends are often slashed when the economy is in crisis, but not when the market is correcting. Market and stock price swings have no effect on a company’s dividend payments because dividends are not linked to stock price.
How long do you have to hold a stock to get the dividend?
Holding the shares for a minimum number of days is required to get the 15% dividend tax rate. Within the 121-day window surrounding the ex-dividend date, that minimal term is 61 days. At 60 days prior to the ex-dividend date, the 121-day period begins to run.
