Dividend Investing - Spotting and Avoiding the Dividend Traps!

Summary

The 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

00:00

🚨 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.

05:02

⚠️ 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.

10:03

📉 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.

Keywords

💡Dividend Trap

A 'Dividend Trap' refers to a stock that appears attractive due to a high dividend yield but has underlying financial issues that make sustaining the dividend unlikely. The video warns against investing in these stocks because they can lead to losses due to declining stock prices or dividend cuts, as seen with examples like Whirlpool and Verizon.

💡Dividend Yield

Dividend yield is the percentage of a company's stock price paid out to investors in dividends annually. In the video, high dividend yields (5%, 6%, or even 8%) are presented as appealing but can signal a dividend trap if the stock price is declining and the company’s financial health is weakening.

💡Free Cash Flow

Free cash flow is the cash generated by a company after accounting for capital expenditures, which is available to pay dividends or reinvest in the business. The video emphasizes that declining free cash flow is a red flag for dividend traps, as companies need strong cash flow to sustain dividend payments, like the case of Whirlpool.

💡Payout Ratio

Payout ratio is the percentage of earnings or free cash flow a company uses to pay dividends. A high payout ratio, especially above 75%, suggests that the company might struggle to maintain its dividend. The video points out that companies with payout ratios above this threshold, like Verizon, could face dividend cuts.

💡Price-to-Earnings (PE) Ratio

The PE ratio measures a company's current share price relative to its per-share earnings. A low PE ratio might suggest a stock is undervalued, but in the context of the video, it can also be a red flag if the company’s price has declined due to underlying financial issues, making the stock a potential dividend trap.

💡Debt Levels

Debt levels refer to the amount of borrowed money a company has. In the video, rising debt is considered a significant warning sign for dividend traps. High debt means companies have to prioritize debt payments over dividends, which can lead to dividend cuts, as illustrated by Verizon and Whirlpool's rising debt and declining cash flow.

💡Earnings Decline

An earnings decline happens when a company's profits decrease over time. The video mentions that earnings declines can signal a struggling business, which may be a candidate for a dividend cut. Companies like Verizon are used as examples where earnings stagnation contributes to a risky dividend investment.

💡Dividend Cut

A dividend cut occurs when a company reduces the amount it pays out to shareholders. The video highlights this as the worst-case scenario for dividend investors and uses companies like Walgreens and AT&T, which cut dividends after struggling with cash flow and debt, to show how dividend traps unfold.

💡Capital Appreciation

Capital appreciation refers to the increase in the value of an investment or stock over time. The video contrasts the allure of dividend yields with the need for capital appreciation, noting that relying solely on dividends without capital growth can expose investors to greater risks, especially in dividend traps.

💡Screener

A screener is a tool investors use to filter stocks based on specific criteria, such as high dividend yields. In the video, the narrator discusses how investors using screeners to find high-yielding stocks might fall into dividend traps if they overlook warning signs like declining free cash flow or rising debt.

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