Dividend Investing - Spotting and Avoiding the Dividend Traps!
Summary
TLDRThe video discusses the risks of investing in high-dividend-yield stocks, known as 'dividend traps.' While high yields may seem attractive, they can signal underlying financial issues, such as declining stock prices, rising debt, and unsustainable payout ratios. Companies like Whirlpool, Verizon, Walgreens, and AT&T are analyzed as examples. The video emphasizes the importance of quality businesses and warns that chasing high dividends without considering fundamentals can lead to financial losses, particularly through dividend cuts. The goal is to help investors avoid these traps and make smarter, more reliable investment choices.
Takeaways
- 💡 Dividend traps are stocks with high dividend yields that decline over time due to poor business performance.
- ⚠️ A high yield dividend (e.g., 6-8%) is often a red flag, signaling a low share price rather than strong business fundamentals.
- 📉 Declining stock prices can indicate a company's financial trouble, often due to industry struggles or poor decision-making.
- 📊 Rising debt levels in a company reduce free cash flow, impacting the ability to sustain or grow dividend payments.
- 💰 High payout ratios, especially over 75-80% of free cash flow, are unsustainable and may lead to future dividend cuts.
- 🚨 Whirlpool (WHR) is cited as a potential dividend trap with declining free cash flow and rising debt despite a high dividend yield.
- 📉 Verizon (VZ) has a slowing dividend growth rate, massive debt, and low potential for business growth, making it a risky dividend stock.
- 🔴 Walgreens (WBA) has already cut its dividend due to poor financial health, declining free cash flow, and massive losses, highlighting its status as a dividend trap.
- 📉 AT&T (T) previously cut its dividend but seems to be on a slow recovery, with improving cash flow and debt reduction.
- 🛑 The key to avoiding dividend traps is focusing on quality companies with strong fundamentals rather than being lured by high dividend yields.
Q & A
What is a dividend trap?
-A dividend trap occurs when a stock offers an attractive dividend yield, but its price and dividend steadily decline over time. This often happens when a company’s stock price drops, making the dividend yield appear high, but the business is actually in poor financial health.
Why can a high dividend yield be a red flag?
-A high dividend yield can signal financial trouble because it often results from a declining stock price. As the stock price drops, the dividend yield rises, which can attract investors. However, if the company's underlying business is deteriorating, this high yield might not be sustainable.
What are some signs of a dividend trap?
-Key signs of a dividend trap include a high dividend yield due to a low stock price, recent price depreciation, increasing debt levels, declining free cash flow, and a high payout ratio (especially when it exceeds 75-80%).
Why is recent price depreciation a red flag for dividend traps?
-Recent price depreciation can indicate that the company is underperforming or has faced a negative event that scared investors. If this trend is due to a fundamental decline in the business, it suggests that the company’s financial health is deteriorating, making its dividend less reliable.
How does rising debt levels contribute to a dividend trap?
-Rising debt levels can lead to higher interest payments, which reduce the company’s available cash flow. As more cash is directed towards servicing debt, less is available for dividends, increasing the risk of a dividend cut.
What is a payout ratio, and why is it important for dividend sustainability?
-The payout ratio measures the percentage of a company’s earnings (or free cash flow) paid out as dividends. If this ratio is too high, particularly above 75-80%, the company may struggle to sustain its dividend payments, especially during financial downturns.
What makes Whirlpool a potential dividend trap?
-Whirlpool has a high dividend yield of 6.84%, but its free cash flow has significantly declined, debt levels have risen, and its sales have been flat. These factors suggest that Whirlpool may struggle to sustain its dividend, making it a potential dividend trap.
Why is Verizon considered a potential dividend trap?
-Verizon’s dividend yield is high, but its free cash flow payout ratio has risen to 86%, and its dividend growth rate has slowed, not keeping up with inflation. With massive debt and flat financial performance, Verizon faces challenges that could lead to a future dividend cut.
How did Walgreens become an example of a dividend trap?
-Walgreens had a high dividend yield of 7.6% but suffered from declining free cash flow, poorly executed acquisitions, and a series of operational issues. In 2024, Walgreens cut its dividend, confirming its status as a dividend trap.
What steps has AT&T taken to recover after being a dividend trap?
-After cutting its dividend in 2022, AT&T has focused on paying down debt and increasing free cash flow. While it is too early to fully judge, these actions indicate that the company is attempting to turn around and restore financial stability.
Outlines
🚨 Avoiding the Allure of High-Yield Dividend Stocks
Many stocks with high dividend yields can seem attractive, but they often come with significant risks. Investors might be drawn to low PE ratios or regular earnings beats, and the allure of high dividend yields can make them overlook the need for growth. However, these stocks can become unreliable if their dividends dwindle. This video explores 'dividend traps'—stocks that offer high dividends but are risky, with declining prices and financial instability. The key is focusing on quality first when building a dividend portfolio to ensure predictable, sustainable returns.
⚠️ Whirlpool: A Potential Dividend Trap
Whirlpool (WHHR), known for home appliances, presents signs of being a dividend trap. Its dividend yield has grown to 6.84%, but troubling financial metrics such as declining free cash flow, flat sales, and rising debt suggest issues. While the dividend hasn't been cut yet, these factors signal potential future challenges. The share price has dropped by 16% this year, and the company may face tough choices ahead, including a possible dividend cut, as it grapples with these financial pressures.
📉 Verizon: Attractive Yet Troubling Dividend
Verizon Communications (VZ) is popular for its high dividend yield, which recently hit 6.1%. However, concerns are rising about its sustainability, with a free cash flow payout ratio of 86% and slow dividend growth—just 2% year over year, failing to keep pace with inflation. Verizon's high debt levels and flat sales in a saturated U.S. market make it a risky investment. With its financials showing little room for growth, Verizon could be another candidate for a dividend cut, placing it squarely in the 'dividend trap' category.
💸 Walgreens: A Clear Dividend Trap Example
Walgreens Boots Alliance (WBA) is a textbook example of a dividend trap. After years of poor acquisitions and management decisions, Walgreens cut its dividend in fiscal year 2024. Its free cash flow payout ratio exceeded 1,000%, and the company's stock has lost two-thirds of its value in 2023 alone. Walgreens' declining financial health—flat sales, declining earnings, and cash flow—shows that it's a struggling business. For investors, Walgreens represents the ultimate cautionary tale in avoiding dividend traps.
🔄 AT&T: Recovering from Dividend Trap Status
AT&T (T) was once a dividend trap, having cut its dividend in 2022, but is slowly showing signs of recovery. Its free cash flow and profitability have improved slightly since the dividend cut, and its yield has stabilized at 5.15%. The company has been paying down debt and improving its financials, indicating a potential turnaround. Although still a risky investment, AT&T's recent progress suggests it may be moving in the right direction, unlike other dividend traps discussed.
Mindmap
Keywords
💡Dividend Trap
💡Dividend Yield
💡Free Cash Flow
💡Payout Ratio
💡Price-to-Earnings (PE) Ratio
💡Debt Levels
💡Earnings Decline
💡Dividend Cut
💡Capital Appreciation
💡Screener
Highlights
Dividend traps are stocks whose price and dividend decline steadily over time.
A high dividend yield is often a red flag for a potential dividend trap.
Rising or high debt levels in a company can signal an impending dividend cut.
A dividend trap often features declining free cash flow, which affects the sustainability of dividend payments.
Companies with a payout ratio above 75-80% of free cash flow are at risk of not sustaining dividend payments.
Whirlpool, with its high dividend yield, rising debt, and falling free cash flow, is a potential dividend trap.
Whirlpool’s share price has dropped 16% year to date, indicating potential financial issues.
Verizon has a high 86% free cash flow payout ratio, putting it at risk of a dividend cut.
Despite Verizon’s 7% dividend yield, its low dividend growth fails to keep up with inflation.
Walgreens' dividend payout ratio exceeded 1,000%, leading to a dividend cut in fiscal year 2024.
Walgreens has experienced steady declines in free cash flow and store closures, indicating poor financial health.
AT&T cut its dividend in 2022 and has shown signs of stabilizing with improvements in free cash flow and debt reduction.
Companies with flat or declining sales and operating income often signal that they are in financial distress.
Dividend growth is crucial for long-term passive income, but high yields can sometimes mask underlying issues.
To avoid dividend traps, investors should focus on a company’s overall quality, not just the dividend yield.
Transcripts
avoid the traps many stocks have an
alluring appeal to them a low PE ratio
maybe they beat earnings estimates
regularly or they have the ultimate
siren song a high yield dividend it
seems so nice a five six or even 8%
yield on your investment automatically
without even the need for capital
appreciation sometimes you can even talk
yourself out of the need for growth for
that sweet sweet dividend yield but as
enticing as these stocks are it is one
of a few red flags for the dreaded
dividend
[Music]
traps welcome to the Quality investor
dividend investing is an important part
of overall investing while my channel
focuses on quality businesses first and
foremost a secondary aspect of the
quality investor is dividends ultimately
one of my goals is to build a large
portfolio of passive dividend income the
truest form of passive income there is
however it is important to focus on
quality first when constructing a
portfolio because of the quality is not
there all those secondary factors like
dividends have the potential to dwindle
and that is unreliable the opposite of
predictable and predictability is one of
the traits of quality so on today's
video we are discussing the dreaded
dividend traps what is a dividend trap
how can we spot them we are going to
answer the these questions so that we
can build the best possible portfolio to
achieve our own goals what is a dividend
trap first off they are attractive
perhaps you have a screener set up for
high yielding dividends and you see some
of those juicy 6 to 8% yields that's way
better than high yield savings account
and even money market funds and there's
the potential for capital gains but
before we get into it please like this
video And subscribe to the channel it
only takes a second helps us grow and
you can stay on top of all the quality
businesses is in the market but a high
yield is often the first red flag so we
can define a dividend trap as a stock
whose price and dividend decline
steadily over time the yield is high
because the share price is low yield is
dividend per share over price therefore
the lower denominator or Price the
higher the yield or dividend as a
percentage of price the next red flag is
recent price depreciation a declining
stock price can mean a number of things
it could be out of favor by the market
maybe a bad couple of quarters of
earnings scared the market perhaps some
negative event hit the business and the
market is panic selling here it is
important to parse the financial data
are earnings down due to Industry sick
locality or is this a sustained downward
Trend because the business is declining
in sales and market share has the
business made some poor Acquisitions
that are burning up operating cash flows
a lower stock price not only makes the
dividend yield look more attractive it
makes the PE Ratio look lower as well
many investors consider a low PE ratio
as a stock that could be on sale usually
though it is the mark of an average or
declining business rising or high debt
levels is another sign of a dividend
trap increasing debt means increasing
interest payments and interest payments
eat away at net income is an obligation
that a business must pay and It
ultimately detracts away from the cash
that is available to investors free cash
flow not only that but debt must be paid
off if debt loads become unnecessarily
High a business will have to prioritize
using cash flow to service debt instead
of returning that Capital to investors
in the form of dividends this could lead
to the worst possible outcome for
dividend investors a dividend cut and
this leads to the final red flag on our
list High payout ratios a payout ratio
is traditionally a percentage of
earnings that the company pays out as a
dividend but I prefer a narrower
definition I like to look at what
percent of free cash flow a business
pays out as a dividend this is because a
business can only pay its dividend from
cash available to its owners which is
free cash flow once that free cash flow
payout ratio creeps up above 75 80%
it will be very difficult for a business
to sustain that dividend payment over
time a business must throw off lots of
excess cash to not only pay out its
dividend but to increase that dividend
over time declining free cash flow is a
symptom of a declining business so let's
take a look at some businesses that fit
each one or more of these red flags that
way we can avoid these dividend traps
and invest our hard-earned money wisely
the first company on our list today is
Whirlpool ticker
whhr they distribute all sorts of
appliances that you'll find around the
home refrigerators washer and dryers so
on so a business that makes everyday
life a little bit easier with the amount
of household labor and as you can see
here we're going to look at our first
red flag a high dividend yield since
fiscal year of 2021 that yield has
popped to 5.7% at the end of their
fiscal year 2023 not only that you can
see that that dividend growth has slown
down a little bit here and we can also
see that that free cash flow payout
percentage has also spiked up in fiscal
year 2023 and we can see here why their
free cash flow has seemed to fallen off
a cliff here so while their dividend has
steadily grown in the past 10 years or
so the free cash flow has not kept up
recently so to me looking at these
dividend metrics right now this is right
here signals a company that could be a
dividend trap looking into their numbers
a little bit further their share price
right now is
$124 we can see that's down almost
16% year to date and their current
dividend yield is at
6.84% so that yield has gone up even
more another red flag to point out look
at their total debt that has risen while
their cash has also fallen so this is a
company that is seing rising debt levels
their free cash flow is falling their
dividend yeld is rising you can see that
their sales have pretty much been flat
in the last 10 years the earnings are
all over the place to me Whirlpool is a
great example of a business that is a
dividend trap while their dividend has
technically not been cut it is flat in
fiscal year 23 versus fiscal year 2022
but if this trend continues declining
free cash flow flat sales Rising debt
levels they're going to have to make
some tough decisions especially if they
need to start prioritizing pay paying
down that debt over Distributing
dividends to investors and that of
course means a potential dividend cut
the next example I want to show is
Verizon communications ticker VZ Verizon
seems to be talked about a lot in the
dividend community on social media and
rightfully so they have that very
attractive yield 7% at their last fiscal
year but as we can see here that is a
rising dividend yield and their free
cash flow payout has been kind of high
historically but an 86% free cash flow
payout ratio that is definitely a cause
for worry and another aspect to consider
is that dividend growth percent the
year-over-year growth percent has been
slowing down a lot it's slowing down
because they want to keep paying that
dividend they've had 17 consecutive
years of dividend growth now they want
to keep increasing that dividend for
investors but they know that it's
getting tougher to afford paying out an
increasing dividend year after year
another problem with slowing dividend
growth is let's be honest 2% dividend
growth year over year that does not keep
Pace with the current inflation
environment that we're in so even though
that dividend is growing investors that
are relying on Verizon for dividend
income they're actually losing money
because their dividend is simply not
growing at the pace that inflation is
going you can see their free cash flow
just simply has not risen along with
that dividend and if we look at their
overall financials here you see that
dividend yield has come down to about
6.1% as of right now and that's due to
the fact that the share price has
increased this year year to date it's up
almost 18% it's currently sitting at
$443 but the rest of their financials in
my view do not look good they have
massive amounts of debt and of course
they are very very Capital intensive
business due to the type of business
they operate telecommunications requires
a lot of capital in order to set up the
infrastructure for a nationwide network
but we can see that they just don't
generate the type of operating cash
necessary to compound that growth over
time their sales are very flat as is
their operating income this is a no
Growth Company they're so saturated in
the market in the United States now
there's just not a lot of room left for
them to grow and eventually they're
going to have to pay down this debt so
as Verizon's less than Stellar balance
sheet catches up with it in my view
they're a big candidate for a dividend
cut and thus a dividend trap next I want
to look at Walgreens boots Alliance
ticker WBA I have been very critical of
this business in the past I use them
often as a example in many different
ways on what to look out for for a
poorly run business and as a dividend
trap it's no different Walgreens cut
their dividend at the beginning of their
fiscal year 2024 so it's not reflected
in this chart here but now their
dividend is only $1 per share at the
time when their fiscal year 2023 closed
their yield was at 7.6% their free cash
flow payout ratio was over 1,000% their
free cash flow has been declining for
years you can see that year-over-year
divid growth slowing right before that
dividend cut all the signs were there
for this business prior to that dividend
cut signaling to the market what a
dividend trap this business is is a very
poorly run business they made some
horrible Acquisitions seemingly year
after year starting in the 2000s and it
all caught up with them after about 2016
when things started just to seem to fall
off the rails for Walgreens their
closing stores left and right Nationwide
they've gone through quite a few CEOs in
the last couple years like I said their
current dividends at 1 $1 and their
current dividend yield is at
115% their current share price is at
$871 they have lost
66% on the year an investment in
Walgreens on January 1st
20124 has already lost 2/3 of its value
we can see their threeyear
annualized return is at negative
43.5% their five-year annualized
return is at negative 30.8% and their
10-year
annualized return is at a negative
18% as an investor 10 years ago today if
you invested in Walgreens you would have
lost on average 18% of your money each
year and it's not just the dividend Cuts
they've been suffering they've lost
their status as a Dow Jones Industrial
Member One of 30 that make up that index
they were replaced by Amazon by the way
you can see as the sales have just
flattened out after
2016 the earnings slightly declining
some terrible years Co year
notwithstanding the cash flow just
steady decline since about 2016 there's
nothing about this business that signals
Health that signals please invest this
is in my view the ultimate dividend trap
and the last business I want to look at
today is AT&T AT&T is a former dividend
risk RP that had to cut their dividend
in fiscal year of 2022 they haven't
increased it since then however it seems
like they're back on track at least
they're turning things around albeit
slowly you can see up to that dividend
cut that steady rise in the dividend
yield signaling dividend trap status but
since the cut it has fallen now their
dividend is currently at
a111 the yield has come down even
further since from that 6.6% to 5.15%
three Cash payout again coming down now
at 39% and that's going to happen when
you cut the dividend you're going to
free up more cash flow either pay down
debt reinvest back into the business to
get growth back on track and you can see
perhaps they are turning around since
that dividend cut still a small sample
size but fre cash flow per sharees
increased since 2022 while their sales
have definitely declined it's a slight
increase year-over-year from fiscal year
2023 over fiscal year 2022 you see here
too that operating cash slightly
increasing so again very small sample
size it appears that AT&T has a long way
to go but it seems like management has
made some decent decisions it is
starting to turn that massive ship
around and things may be getting better
for AT&T they are up year-to date 28%
after all you can see here that they've
used that excess free cash flow to pay
down some debt and if we look at the
profitability you can see it's steadily
increasing again so things seem to be
back on track for AT&T or at least
heading in the right direction these are
just a few examples of what to look out
for for dividend traps like I said
whirlpool and Verizon seem to be prime
candidates for a dividend cut in the
near future all the signs are there and
if you compare them to what Walgreens
was prior to their dividend cut it looks
like the same type of situation so you
don't want to invest in a dividend trap
if you're relying on that growth year
after year we relying on dividend as
passive income and hopefully today I
gave you some good solid red flags to
watch out for before investing and those
very attractive high yield dividend
stocks thank you for watching today's
video and if you've made it this far go
ahead and subscribe to the channel thank
you and happy investing
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