As a dividend-focused investor I’m always on the lookout for high yield shares, whether that yield is high relative to the market average or high relative to the company’s peers.
However, as most yield-seeking investors soon discover, high yield stocks do not always deliver the yield you were hoping for. That’s because dividends can be cut or even completely suspended, and the higher the historic or forecast yield the more likely that is to happen.
This is the dreaded yield trap, where investors are lured in by an attractive yield and then stung with a capital loss when the dividend is cut.
In order to avoid this fate where possible, I’ve built up a series of questions which every potential investment must answer before I’ll invest so much as a penny. These questions are designed to help me avoid companies that are exposed to significant risks, where those risks arise from factors such as large acquisitions, excessive expansion or changing patterns of market demand.
Of course, these questions are not foolproof, but I’ve found them extremely useful in recent years and in the latest issue of Master Investor magazine I’ve covered the first six yield trap questions in some detail:
How to avoid yield traps – Part 1
Hi John, A very important topic and one too take notice of and to keep referring back to as you get tempted on anything that looks cheap.
This is another article along the same lines.
Phil Oakley wrote a sensible piece and picks out 3 that are perhaps worth a decision on :
Of the 3 chosen, I agree with him on Greene King, and have invested at the lows, (well the most recent lows I mean). I don’t necessarily agree on BT and I’m on the fence with Next. Whilst it has an unquestionable history, I always get the nagging feeling every time I walk past or into the shops which are largely empty and big.
John Kingham says
Hi LR, yes I saw that article from Phil; he’s definitely one of the better sources of info out there.
As for his three stocks with “potential to bounce back”, I’ve written about BT before and was very negative on its financial obligations in terms of debts, pension liabilities and capex requirements:
I haven’t looked at Greene King in detail, but my stock screen seems to think it has a colossal debt pile, and I recently bought Next and still think it’s attractive.
Hi John, undoubtedly GNK has chunky borrowings at about £2.2Bn, however it has £3.6bn of property and the company has generated positive cash increases almost every year.
This is against annual operating profits of close to £370M.
Net gearing has fallen from 157% 5 years ago to about 103% this last May.
The P/E is now at historic lows at 9.5 and the earnings growth is slow but steady. Dividend yield is 4.9% and is covered more than twice by profits and well covered by free cash flow.
The places I visit – Old English Inns – Loch Fyne etc are well attended and seem quite well organised.
It’s not without risk of course, but I have a theory regarding the pub business and that’s that they are to become a rarity.
6 years ago there were over 85,000 pubs — today it’s 50,000+. the closure rate is falling, but it’s still significant and many small landlords are giving up. Greene King has taken out Spirit so that leaves a handful of competitors – Mitchels; Fullers; Punch and and a load of regional charlies.
It’s sitting at 0.89% of my portfolio and given it’s long history of divi increases and never missed a divi in over 20 odd years I’m willing to give them the benefit of the doubt. The beers pretty good also which is a bonus and I get 20% off my bill as a shareholder perk — so that’s nice!!
John Kingham says
Your point about property is a good one. I think companies that buy rather than rent their properties will do less well on my stock screen than those that lease property. Buying property means that the financial obligation is on the balance sheet as a liability and the property is on there as an asset. The increased liabilities will make the company’s debts look worse (according to my debt ratio) and the increased assets will make its profitability (return on capital employed) look worse as well.
This is a bug in my investment process, but it’s a very minor one. Most companies don’t have huge amounts of mortgaged or owned property on their balance sheets and so there are still many, many other companies that I can invest in where this isn’t a factor. This may mean that I miss out on the occasional opportunity (perhaps GNK?) but I don’t think that will keep me awake at night!
Having said that, it is something I might try to fix in the future.
“but I don’t think that will keep me awake at night!”
John, probably nor should it. I’m generally not a fan of heavily property weighted properties, GNK is somewhat an exception alongside Fullers who seem to have even more favourable and greatly undervalued set of prime real estate that has never been revalued for the reason you put earlier (it affects the ROCE number – which seems to have a great sensitivity amongst the investment community).
Burberry is doing OK — what do you think of today’s announcement regarding the deal with Coty? I must confess I don’t know if it makes sense or not, other than to note that they seem pretty confident it will be earnings enhancing from 2018 onwards. I can wait that long. I hope it’s a winner mind as it’s 4.15% of my portfolio and one of my top 10 performers in the last 12 months.
John Kingham says
On Burberry/Coty, I don’t really have an opinion. There isn’t much detail in the announcement and in general I prefer to let management get on with the job of running the company. I’ll have an opinion on the deal once I have a few years of hindsight to go on.