The Dividend Trap

Looking at the sea of red now suddenly gives me a lot of inspiration to write. In times of peace I was like in slumberland for blogging. So while I am awake, I wanna shoot at this very hot investment term - DIVIDEND.

Is dividend yield the most important when you make a stock buy decision?

Do you frequently look at dividend trackers?

Is your investing goal or objectives mostly revolving around dividend yield?

If all your answers are YES, then you might have fallen into the 'Dividend trap'.


Since Dividend yield = Dividend yield ($) *100/ Price of share ($), when there is rapid market melt-down what do you think happens? Dividend yield shoots up! Then you thought "GOOD AH, BUY AH! Passive income ah!".

If you scrutinize further, often the stock which dividend yield shoots up like crazy (in beyond 10% range) are often companies which are most impacted by the ongoing economic changes or the weaker ones with say higher liabilities, weak earnings or poor growth. This is because other investors are dropping them like hot coals.

Some questions to ask are...

1. In times when the market recover, would their share prices recover as fast?
2. Are their business robust enough to weather the rough economies?
3. Are their high dividends sustainable with their current cashflow?

Some businesses that pays good dividends are cyclical. Meaning that they do well when their industries do well and that explains the high dividend payout but once the spotlight is off and curtain's closed, the dividends would drop. Some examples are agriculture, properties and oil-rig companies.

Do note also that some companies gave inconsistent dividend payouts. For instance, on some years there are special dividends due to asset disposal or exceptionally good earning. So that one year does not represent the norm. Therefore,  I would advise looking at their 5 years dividend payout history, otherwise 10 years if it has been around for that long. You can view the accurate payouts via the SGX's website. Another factor to consider is the whether the % payout is sustainable given the company's current and projected future earnings. You can calculate the Payout Ratio to check if the company is overpaying what it can afford from its earning - if the payout ratio is too high, it would be a warning sign to its sustainability.


Looking high dividend yields may be a trap if you use that as the only stock screening criteria. Stock picking or analysis ought to be more like watching a 3D movie with surround sound - we look at the micro (stock indicators for TA), micro (fundamental /moat) and macro (world economy), instead of a snapshot which is just 2D.


Looking at P/B, ROE, debt/price ratio or P/E might not even be good enough to justify a buy (as there are more factors to take into account), much less dividend yield. I am sure you vaguely remember something about 'not to drive by looking at the rear-view mirror'?


The dynamic factors changing ahead of you that affect these ratios are share prices (price momentum), future earnings, future liabilities due, assets revaluation etc.


An increase in capital return is always superior to taking 'panadols' (dividends used to ease heartache). Any day.

"Buy a good company at fair price or a fair company at good price?"

You make your choice.

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